Chrysler’s former senior creditors have complained bitterly about the value they are to receive in the current bankruptcy settlement proposals. There has been lots of talk about what is “legal” under Bankruptcy Code Section 363, which allows for asset sales by debtors facing bankruptcy. Some lenders have also groused about how the government has “unfairly taken” property from bondholders. Our view, given our previous experience in junk bond portfolio management: while pre-existing lenders have every right to make their case in the press, they protest too much.
We know full well that in most cases senior creditors have a high priority claim on bankrupt companies’ assets, but (you knew there was a “but,” coming, didn’t you) senior creditors also know that in the ordinary course of Chapter 11 bankruptcy they get bumped down the line if a new party lends new money to keep the company going while it restructures. Usually that money takes the the form of debtor-in-posession (DIP) financing, which the government in fact provided. DIP financing immediately becomes senior to the claims of ALL existing lenders, according to well established precedent. Which makes sense because, a company goes bankrupt if it can’t repay its existing lenders. Why would a new lender step into the same position as the existing lenders?
Back in the 1990s when an over leveraged company with a good business model went bankrupt, it immediately lined up DIP financing to keep itself functioning while it restructured under court protection from creditors. Now DIP financing is harder to come by, as the banking system is weak and fromer key non-bank DIP lenders like GE Capital have also pulled back from the business. We can’t know if Chrysler would have gotten private DIP financing in the Nineties, but they failed to find it this time.
Therefore, the government (us taxpayers!) found it necessary to provide Chrysler’s DIP financing. This is an extraordinary situation, a loan by the taxpayers made to save a shaky company in a highly competitve industry. No one should be surprised that the government, which negotiates from a position of legal strength as a DIP lender, is trying to exact the terms it wants from the now more junior lenders.
Moreover when the old lenders cry foul they are asking to bailed out of some outlandish stupidity. These lenders financed the leveraged purchase of Chrysler from Daimler-Benz by the Cerberus private equity firm, a deal that helped signal the market top. Back in the heyday of LBOs, in the Eighties, investors knew that the purpose of an LBO was to unlock value from a non-cyclical company with stable cash flow. LBO deal makers targeted companies that could service a heavy debt load even during recessions. Leveraging up a cyclical company has always been thought imprudent, and leveraging up Chrysler, of all companies, really took the cake. The lead banks knew this deal was the industrial equivalent of a NINJA mortgage (no income, no job, no asset verification) and after originating the loans they hoped to sell these loans to others rather than keep them on their own books. But in the summer of 2007 the music stopped, and their bridge loans became non-salable, “pier” loans, as in, bridges to nowhere. Should they be spared a hit for this stupidity? Not in a capitalist system they shouldn’t. And that goes for all of Chrysler’s lenders, whether they’ve accepted TARP funds or not.
If the private lenders think the government is getting “too much,” or being too generous to the unions, they should remember this. The pre-existing lenders had their chance to put more money into Chrysler. They could have created their own senior DIP facility to keep Chrysler going, but they chose not to. So Chrysler went bankrupt, the government is playing a large role in Chrysler’s rescue, and the private lenders are shocked, shocked, that they don’t control the situation.
The original lead bank lenders might well have been right to let Chrysler go. By chipping in more they’d have risked throwing good money after bad, in a deal they’d never wanted to own for more than 90 minutes. But when a white knight saves the day by bringing gold, he makes the rules.