Shocked, Shocked

Steve Jakubowski has a great new post up summarizing the bankruptcy court's decision in Chrysler, and in it he makes plain an argument that I've only referred to obliquely. In particular, in both GM and Chrysler many of the banks, hedge funds, and other institutional creditors are getting a taste of their own medicine, and they hate it.

In the past decade lenders have learned how to play the chapter 11 game.  They lock up all of the debtors assets with security interests and make strong demands, like quick 363 sales and "roll overs" of pre-petition debt into post-petition credit lines, as the price for allowing a reorganization case to even happen. In this way, the Treasury is simply playing the institutional lenders' game -- exerting a lot of control over the chapter 11 process as the result of the DIP financing it is providing.

Thus, when I see these same institutional investors acting like Captain Renault, I'm skeptical.  And when I see the financial press suddenly expressing shock at these practices, I say "where have you been?"

Comments

[TD]

A bit cynical...what the banks cannot believe is that anyone would provide $33bn of post-filing financing with the full intent of losing a significant portion of it. The consideration received by the UST may, or may not, be its own to give away to the UAW. As a matter of policy, the true question is whether the US government should donate its recovery value to fund a private company's health care benefits.

[Stephen Lubben]

I think you're right that there are serious policy questions here -- but I also think people should stop pretending that what is happening is some massive departure from the norm in large chapter 11 cases. A policy debate does not equal a violation of the Bankruptcy Code.

[Tim]

Agreed. Very well thought through by Jones, Day.

[Lawrence D. Loeb]

I'm not sure where you are coming from in relation to the statement that "They lock up all of the debtors assets with security interests and make strong demands."

During the Congressional hearings, at the beginning of April (see http://judiciary.house.gov/hearings/hear_090311_1.html - they now have a transcript) there have been changes in the markets, as well as in the Code, that are leading this cycle to outcomes not seen previously. I discussed this in two posts (http://blog.lawrencedloeb.com/2009/04/whats-wrong-with-bankruptcy-code.html and http://blog.lawrencedloeb.com/2009/04/why-doesnt-anybody-want-to-take-dip.html).

In past cycles businesses HAD assets that hadn't been liened, or at least there was adequate coverage for existing lenders to be primed by a DIP. Changes in the financial markets over the last several years have led to an increase in secured lending relative to unsecured/junior financings.

Specifically, the CLO structures allowed banks to make more loans than ever, package them into structured vehicles, and then recycle their cash (make a new loan since the old one was off their books). These loans were attractive to borrowers because they were cheaper (lower interest rates) and, when the market got overheated, there weren't many covenants to worry about.

That helped to lead into the prevalence of Second Lien and Third Lien debt.

This gorging on bank debt has led to distressed situations where there are no assets for a new lender to secure a DIP against. THAT is why existing lenders have been rolling up existing loans into DIP proposals (and getting away with it). It's the most economic situation given that any unsecured DIP lender would have to be willing to provide the exit financing and/or to take a significant equity stake upon exit (since they would still have administrative priority).

The holders of the CLOs don't participate in the DIP deals.

Perhaps you believe the syndicating banks hold the loans they make? That used to happen (and, arguably, led to better credit analysis), but lead banks only own part of their loans these days.