To all the proponents of an automaker Chapter 11 filing, Corinne Ball offers this advice: be careful what you wish for, especially when it has never been done before.
As head of the Jones Day team advising Chrysler, Ball is juggling her time between Detroit, Washington, and New York, where she is co-head of her firm’s restructuring group.
The bankruptcy veteran finds it remarkable that so many experts are willing to use what she calls a microeconomic tool — Chapter 11 — to help us out of our macroeconomic problems.
Over the course of her career, Ball has worked on many notable assignments, including the Chrysler workout in the Lee Iacocca era, Olympia & York’s restructuring and Drexel Burnham Lambert’s landmark bankruptcy. She studied law at George Washington University and her first job was with Weil Gotshal, where she worked for 23 years with a restructuring team headed by Harvey Miller.
She remembers clearly her first day at the office: “Ira Millstein [Weil Gotshal’s senior partner] brought me into a conference room and there was [Mayor] Abe Beame signing a bankruptcy petition for the City of New York. They were ready to go Chapter 9. That was my first assignment, working on rescuing the city. How could you not resist working on the biggest rescue that anyone had seen at that point?”
Last week, Ball sat down with IDD to talk about the current bankruptcy backdrop. Following are excerpts from the interview.
IDD: How is Chapter 11 fundamentally different in the current economic environment?
BALL: Chapter 11, either as it currently exists or as its predecessor Chapters 10 and 11, didn’t come into existence until the latter part of the Depression, in the late ’30s. So when people say we’re much better off doing this in Chapter 11 and experts agree with them, I’m very curious, because we never tried to use what is, fundamentally, a microeconomic tool, one firm at a time, in the context of a macroeconomic overhang of the dimensions that we have now. It’s never been done.
IDD: To your point about this cycle being different, banks recently backed off from debtor-in-possession lending.
BALL: There is no credit available to refinance debt or finance purchases. Today’s economy is presenting problems of an unprecedented magnitude, leaving highly leveraged companies to confront a credit tightening that was not anticipated by [bankruptcy legislation]. Notably, the “shadow” credit market that we have today is not functioning. In 2006 and 2007, one-third of the credit market came from traditional financial institutions. Two-thirds came from alternate investment sources, a lot driven by asset-backed securities. If you look at the late 1970s and early 1980s, $3 out of $4 came out of financial institutions. If look at 2006 and 2007, only $1 out of every $3 is coming from the source that is [Treasury] Secretary [Timothy] Geithner’s focus. Now, however, we are seeing little or no primary lending, coupled with a downward pricing spiral in the secondary markets. It is difficult to break the fall as long as investors are selling, whether to meet margin calls or redemptions. It also raises the question of where is all this money that used to go to credit markets?
IDD: So credit markets are still wobbly?
BALL: They [lenders and investors] have to choose between an opportunity to do a primary loan or buy in the secondary debt market. They come into the secondary debt market and see the price of fully performing securities paying interest that reflect the market panic and market sale mode and not necessarily the credit of the issuer. They are getting a tremendous yield if those prices are anywhere from 50 to 70 or lower, depending on the credit. They can buy advantageously in the secondary market, achieving yields ranging from 20% to 30%. Or, they can go out into the primary market and do these high-grade bonds or commercial loans. If I have an investor I am responsible to, what am I going to do? Go where I can get these kinds of yields or the primary [market] where yields are lower? I’m obviously going to go secondary.
What has this disparity meant for DIP loans? Lyondell is a classic case to watch. Lyondell needed to raise a huge DIP facility. It’s facing the same pricing and frozen credit that everyone else is confronting. So what does it do? It ends up doing a roll-up and the richest loan that Chapter 11, I think, has ever seen. Lyondell needed new money; it needed a DIP term and it needed a DIP revolver. The revolver world has not changed that much because that is based on the liquidation value of current assets at very favorable rates. It paid off all its pre-petition ABL and it rolled out a new one. What did it do with its term loan? It presented a $6 billion term loan. It needed over $3 billion in new money. In order to get to that level they told everyone who bought this debt at a discount — holders of pre-petition secured debt who bought it in the secondary market — “we’ll let you roll up one dollar of your pre-petition term loan and treat it as a post-petition loan for every new dollar you give us.” The idea of rolling from term pre-petition to DIP loan has the legal effect of saying: “You are at the head of the class. You will be paid off ahead of everyone else.” The rate they paid on the new money was Libor plus 10% with a Libor floor of 3% and an up-front fee of 3%. They also made it only a nine-month loan and they have assessed a 3% exit fee. Although the rolled-up pre-petition term loans are being paid interest at the default rate, the amount of these rolled up loans is included in the fee structure. It’s in large part driven by the investment needs of the alternative investors. Many have to have the loan mature by year end because they need to know where they are for the next year’s investment.
I’m pointing out Lyondell because it brings into vast relief what’s happening to the credit markets and what Lyondell had to do. The structure totally appealed to what is going on in the credit markets, attracting new money with high rates and by permitting those investing in the secondary debt market to enhance their yields.
IDD: When it comes to Detroit’s Big Three, we are hearing more calls for the automakers to restructure in court. Do you think people realize what they’re suggesting?
BALL: I think I know a lot about Chapter 11, and as optimistic as I am, I am concerned that we have not really foreseen [what happens] when you put together no credit, the global and the social [issues] and the backlash of the credit-default swaps market. What do you think is going on with those bondholders in GM? If I bought credit protection I need a credit event. When you say, “Everyone is saying bankruptcy is OK,” who benefits right away? GM is not alone in dealing with that reality of what the CDS markets have done [to the workout process]. Clearly, that is affecting GM. That influences the flexibility of what your bondholders can do. If you don’t have CDS protection, you have to be terrified. I think they are terrified. I don’t think it is just limited to GM.
IDD: You had the experience of Chrysler in the 1980s. Back then, there was a government backstop.
BALL: There was. It was preferred stock.
IDD: Back then, Chrysler actually threatened bankruptcy to get the lenders to work with them.
BALL: In those days, the difference was you could get the holders of the majority of those capital structures — other than the public bonds — into a room. You could get all of the banks into a room and all the insurance companies into a room. We were absolutely dedicated to finding a solution and were content to leave the public [bonds] untouched, even though they were frequently unsecured and the banks were secured. There was a tremendous determination to make it work. That it was too big too fail. That there would be adverse consequences. We were dedicated to finding a solution. We got the banks and insurance companies to put new money in by enabling them to buy secured paper which was not Chrysler debt — receivables of dealers and consumers.
Today, with the amount of credit that is really held by people with those skill sets and that ability, it is only one dollar out of three. You can’t get everyone into a room and you do have to touch the public or widely held loans, because who are holders of the syndicated bank credit? It’s not banks. I can’t go to them and say put up new money in a revolving line for a standby purchase facility. The characteristics of credit have changed so much that it’s driving a different solution.
IDD: If one of the auto giants goes bankrupt, it may drag the other two down, not to mention the parts suppliers.
BALL: One thing we have to hand to the [Obama] administration is that while they may have insisted on a change in leadership in GM, they have been listening to the executives from Detroit saying the kinds of things you’re saying: understand the global supply chain, just-in-time inventory. Understand how important it is all the way down to the mom-and-pop supplier to keep the supply chain in place. They are reacting. Whether it’s perfect, that’s a different question. Whether it’s big enough, [that’s a] different question. But it’s clear the administration is listening. Right now the legacy burden is bad for the manufacturers and it’s bad for the unions. It has to be addressed. They can’t keep jobs for a viable future if these companies are dying under that legacy burden.
One of the major things they are exploring is how you address this macroeconomic [issue]. No transplant has it. Every domestic has it. To the extent suppliers are on UAW contracts, they have it as well. It goes right down the chain. The supplier program, the warranty program, the stimulus on health care — if they can straighten it out — are all reactions to what Detroit’s been trying to tell the government, that this is a macroeconomic problem. This is not just the auto industry.
IDD: Why are more 11s ending up as liquidations?
BALL: There are always two questions that you ask when you come upon a company that’s in trouble: Does it have a reason for living, and who cares? If you don’t get yes to both questions in tough times like this, you are going to end up in liquidation. You have to convince people you are viable and that enough of your constituents care enough that they will make changes, sacrifices to support you to get out.
IDD: What’s behind the increase in Chapter 22s?
BALL: When money was easy, nobody looked at fundamental value. Everybody looked at trading value. In those trading days, if I am into trading value, who am I? I’m probably a hedge fund or an investor without a long-term horizon. If I’m a vendor or the union or I’m someone that’s going to be there, a customer, I’m interested in fundamental value: did you fix yourself? Customers generally don’t vote in a plan. Unions generally don’t vote in a plan. So who’s left in a plan? An awful lot of investors. If you have a short-term horizon, you are interested in fixing the balance sheet, because you are worrying about where that debt is trading. Whether the plan was good or bad was not the focus. The focus was the impact that it would have on the market or trading prices of reorganization securities upon emergence.
In other words, will the bondholders get a quick pop for a confirmation? People wanted to get a quick Chapter 11, to get in and out. They didn’t want to create claims by rejecting contracts or otherwise restructuring the business. They didn’t want to deal with legacy. They didn’t deal with retirees. Addressing those obligations would create claims, although the reorganized company would be healthier and less burdened. But, the claims created would potentially dilute near-term returns for bonds and other funded debt. There was the tendency of many firms to just go along.
IDD: In today’s environment, if I am a 22 am I more likely to be liquidated?
BALL: I would think so. Unless someone meets those two questions: Can this be viable and does someone care?
IDD: Do you think the judges have noticed that we have drifted away from the true ideal of keeping a business alive?
BALL: Right now there aren’t a lot of investors trading in distressed debt, looking for a “pop” in trading prices upon emergence from Chapter 11. What you are really seeing now is vendors who hold the claims. They can’t sell their claims and they still care. You are seeing the unions who care. You are seeing the customers. When you see the involvement of people who care whether a company lives or dies we are coming back to using Chapter 11 as it was intended — even in this awful environment.
IDD: Where are we in the bankruptcy cycle?
BALL: I don’t think we’ve seen the business sectors fall into Chapter 11 that I’m still expecting to see hit by the financial crisis, such as retail, home building and municipalities.
IDD: What are your thoughts about municipalities and Chapter 9s?
BALL: Municipalities are a ticking time bomb. Everyone now is focused on what has happened to their tax base with the devaluation of real estate and the departure of businesses. [But} the elephant in the room frequently — it’s certainly not true for all municipalities, but it was certainly true for the City of Vallejo — are legacy and collective bargaining costs for the municipal unions. What happened in the City of Vallejo is they had a lot of collective bargaining problems. The legal outcome there in terms of collective bargaining agreements and legacy was what we expected: special provisions governing retiree benefits and collective bargaining agreements which are part of Chapter 11 did not apply in Chapter 9. The union and retiree protections technically are part of Chapter 11 and there are no similar protective provisions for unions and retirees in Chapter 9. So, Vallejo rejected its agreements without meeting the stricter standards of Chapter 11.