Bankruptcy snares municipal bonds for wood pellet operator

Wood-pellet manufacturer Enviva Inc.’s bankruptcy has pushed $353 million of municipal bonds along with a wider $2.6 billion pot of debt into a Chapter 11 corporate reorganization.

The municipal bonds are the $252 million in outstanding Series 2022 Industrial Development Authority of Sumter County Exempt Facilities revenue bonds in Alabama and $101 million in outstanding Series 2022 Mississippi Business Finance Corp. revenue bonds. Both bonds are tax-exempt.

Enviva’s from the U.S. Department of Agriculture’s Foreign Agricultural Service.

“The problem with the bonds is the reliance on regulation to create a market for the end product,” said Joseph Krist, publisher of MuniCredit News. A change in overseas regulation of wood for heat kills the credit, he said, adding that it’s the sort of risk that historically ends up in the municipal bond market because its rates are the only ones which allows a project like these to have a hope of repayment.

“Now that bankruptcy has commenced, it’s clear that a significant debt reduction and reworking of contracts will be required to give the credit a chance,” Krist said. “That will be a difficult process which the company acknowledges. I would say that the credit remains in a difficult position given the exposure to regulatory risk.”

It’s not the first time tax-exempt bonds issued for the wood pellet industry have run into trouble.

Such bonds have become entangled in bankruptcy for projects in South Carolina, Louisiana, and Texas.

Following the bankruptcy filing in March, Moody’s Ratings Vice President and Senior Credit Officer Anastasija Johnson and Associate Managing Director Karen Nickerson said, “governance risk stemming from the previous management’s decisions to enter into repurchase agreements with a customer at prices that are substantially above current market prices creating obligations that the company cannot fulfill. These obligations continue to constrain the company even as it seeks to reduce debt by $1 billion through the bankruptcy process as it continues to operate.”

When the 2022 Alabama bonds were issued they carried speculative grade ratings of B1 from Moody’s, B-plus from S&P Global Ratings and BB-minus from Fitch Ratings.

S&P now rates the bonds D, signifying default.

Moody’s downgraded the bonds to C before withdrawing the rating in March. Fitch had lowered its rating on Enviva senior notes to C before withdrawing its rating following the bankruptcy filing.

Simultaneous with Enviva’s bankruptcy filing, it entered into two Restructuring Support Agreements. One was with holders of 78% of the Alabama bonds, 45% of the Mississippi bonds, and holders of the majority of a senior secured credit facility and senior notes. The second RSA provides was with 45% of the holders of the Mississippi bonds.

Under the RSAs the senior secured credit facility will be repaid in full.

On May 8 U.S. Bankruptcy Judge Brian Kenney approved a settlement for the Mississippi bonds whereby money in Enviva’s construction fund — money raised through the bond sale but not yet spent on construction — will be transferred to a settlement fund under the control of the bond trustee, Wilmington Trust. Kenney authorized the trustee to make prorata payments on due principal and interest by July 10 but the trustee can retain money for likely expenses connected to the bankruptcy.

The balance of the money due to the bondholders — money already paid to Enviva to cover construction costs — will be deemed an “allowed claim,” of equal standing to those of the bankruptcy’s other unsecured creditors. At a future point in time the Official Committee of Unsecured Creditors will be allowed to “assert a challenge” to the extent the claim may be asserted against the debtor, Kenney said.

The construction fund for the Mississippi plant, which had been scheduled to open in 2025, contained $70.5 million as of Feb. 29, according to a notice to bondholders from Wilmington Trust posted on the Municipal Securities Rulemaking Board’s EMMA disclosure website.

The Alabama plant, which was farther along in construction, had $52.4 million remaining in its construction fund on Feb. 29, according to a trustee notice.

When it announced its bankruptcy filing, Enviva said it would continue construction in Alabama and pause construction in Mississippi.

In addition to its two tax-exempt bond series, Enviva had $748.4 million of 2026 corporate notes outstanding, and $669 million of secured credit facilities as of Sept. 30, according to the company’s most recent quarterly report.

Some of Enviva’s lenders and noteholders committed to providing $500 million in debtor-in-possession financing, with $150 million becoming available after Kenney approved an interim DIP order in early April. He approved a final DIP order in early May.

On Monday the Official Committee of Unsecured Creditors notified the court that it was appealing the final DIP order.

The lesson these bonds’ bankruptcy for the municipal bond world is “most of these types of deals come to our market after market segments which know better pass on them,” Krist said. “A quarter century of dog and pony shows for private placements teaches you that. At the same time, the lack of new issuance in municipal high yield is going to make people think that they should chase deals. That’s how you wind up with credits like this 
getting a 6% coupon for 30-year debt.” That’s the rate on the Alabama debt, which closed in July 2022. Bonds for the Mississippi project, which closed in November 2022, paid 7.75%.

There are controversies about Enviva’s environmental bona fides and about one of Enviva’s law firms.

“For years, Enviva has deceived customers, destroyed forests, and polluted communities,” said Dana Smith, executive director of the Dogwood Alliance, said in a statement after the bankruptcy filing.  “It’s finally caught up to them. They’ve wasted millions of taxpayer dollars. Our government must not give one more dime to this failing, dirty industry…. We need a shift to forest protection, not more destruction.”

The Dogwood Alliance works to protect Southern U.S. forests and communities from destructive industrial logging.

There has been growing controversy over the role of Vinson & Elkins as one of Enviva’s two bankruptcy law firms. Kutak Rock is the other.

Gerard Vetter, acting U.S. Trustee for Region Four, submitted a brief in early May to the court objecting to Enviva’s application to employ Vinson & Elkins as debtor’s counsel. He raised six different potential and actual conflicts of interest and failures to fully disclose information.

V&E failed to fully disclose connections to several members of a creditors group, Vetter said. “Vinson holds interests adverse to the estate and is potentially and actively conflicted by its simultaneous representation of the debtor’s largest equity holder, officers and directors, and members of [a creditor’s group.] Vinson itself is a creditor that received preferential payments.”

“As unfortunate as it may be for the debtors, their choice of counsel is not disinterested and cannot meet the standards of Section 327(a) [of the U.S. bankruptcy code],” Vetter told the court.

V&E and Kutak Rock responded in early May that V&E had represented Enviva for nine years. They said the court and the trustee had raised two issues: V&E’s representation of the biggest equity owner of Enviva in matters “unrelated to the debtors and these chapter 11 cases and its representation of some Enviva’s directors and officers in pending securities and derivative litigation relating to Enviva.”

“These representations do not impact V&E’s disinsterestedness, nor do they require a wall of separateness,” the law firms told the court.

Last week the trustee and V&E’s attorney argued this matter in a hearing. As of Wednesday morning the judge had not ruled on the matter.

Enviva didn’t respond to a Bond Buyer request to comment.