Fulcrum security
Capital MarketsThe most senior claim not fully covered by the enterprise value, and therefore the class that converts into the new equity.
Also written: fulcrum
The fulcrum is the layer where value runs out. Everything senior to it is money good and expects repayment or reinstatement in full. Everything junior is out of the money and, under absolute priority, receives little or nothing.
Its holders are the ones converted into the equity of the reorganised company, so they end up owning the business. That is why distressed funds buy into that specific layer rather than simply the cheapest paper available.
Where the fulcrum sits depends entirely on the enterprise value assumed, which is why the valuation fight in a restructuring is really a fight about which creditor class receives the equity. Move the value up a turn and the fulcrum moves down a layer.
Identifying it is the first analytical step in any distressed situation, and it requires a defensible going concern valuation before any of the negotiating dynamics make sense.
Worked example
Enterprise value 600, against 400 of first lien, 300 of second lien and 200 of unsecured debt.
The first lien is covered in full. 200 of value remains against a 300 second lien claim, so the second lien is the fulcrum and recovers 67%.
Argue the value up to 750 and the second lien is covered in full, moving the fulcrum down to the unsecured. That is the whole reason the valuation is contested.