Zachary Booker on bridge loans and bankruptcy

This is an email, all from him, I won’t add in any other formatting:

“Like you, I have an extraordinarily deep concern about the capacity for businesses – not only SMBs, but also larger, capital-intensive firms – to weather this path of suppression. I was quite surprised to hear Russ take a lighter note.

…I am deeply sceptical of the efficacy of bridge loans that you spoke about early this morning. While Brunnermeier, Landau, Pagano, and Reis have laid out the best transmission mechanism, I can not possibly envision it will move the needle enough for the majority of those businesses while also not leaving a wake of loss provisions for future generations. I suppose you could say I am partial to point two in your piece.

I also simply can’t understand the legal logistics of bridge loans in this scenario. Most companies will have a capital structure of some kind (perhaps without the most sophisticated lenders). How are you cramming down those who you are priming in the capital structure? You need consent. Who will be managing this incredibly laborious process of gaining consent and creating the terms? Cash grants are one thing, but bridge loans that aren’t unsecured at the bottom of the capital structure are an entirely different matter.”

“While the benefit of hindsight can be a hindrance to pontificating on novel circumstances, it strikes me as unequivocally true that the GFC had a much simpler – intellectually, if not politically – solution. Namely a solution that at its core involved taking known, marketable securities out of the system at haircuts or depressed valuations to abate panic, settle markets, and of course eventually sell at a profit.

In short, I’m partial to the view that mark-to-market accounting was both a central impetus for why the crisis was so severe and why action could be taken so decisively without burdening tax payers for generations to come (see Ball’s very good book here and Fragile by Design, both of which you’re likely familiar with). This crisis provides no such “simple” solutions that can be concentrated against a singular sector of the economy by taking decisive action.

I, of course, have no grand unified theory to share with you. However, I did want to pass along some thoughts I had upon reading your bridge loan piece that came to mind.

Like you, I am also worried about how broad the demand shock is currently and will be moving forward. Affecting not only every industry severely, but also every locality in the economy (e.g. leaving no state or municipality without deep, painful bruises). This raises the question of how the economy – when this is all said and done – reconstitutes itself in an orderly, efficient fashion.

While I’m partial…I believe one of the incredible strengths of the United States is its bankruptcy code. In particular, the out-of-court and Chapter 11 processes.

I would perhaps mull over how the United States can leverage the bankruptcy code to provide support, both out-of-court (e.g. before filing) and to expedite the process while in-court (e.g. by utilizing pre-packs, which are very popular, very quick, and incredibly effective at providing sustainable balance sheets).

The United States could explore offering – or backstopping – DIP Financing for firms that file Chapter 11 (see explainer on DIP financing from Davis Polk here). DIP Financing has been around for many decades, is incredibly safe, and deeply effective.

  1. The US could offer DIP Financing at favourable terms directly and automatically under preset conditions (e.g. a firm that was FCF positive in 2018 with EBITDA +$[10]mln, but needing to file Chapter 11 in 2020, would immediately get a facility at L+[100]). This would also give the US the highest seniority in the cap stack with very favourable terms upon a potential future Chapter 11 (Chapter 22) or a future Chapter 7 (liquidation). For firms that have not been in distress prior to the crisis, this would have the US assuming very little real credit risk. 
  2. The US could backstop private DIP providers – to get credit rolling again – by guaranteeing [95] cents on the dollar for any facility extended within the next [X] months. Historically, DIPs have returned much more than this so this is reasonably safe from a credit perspective. Note: this could also be done for TL1s or revolvers out-of-court. Same principle applies regarding seniority, lessened credit risk, etc. although you’d need consent down the capital structure.
    1. The United States could explore offering participation in pre-packs whereby:
      1. The US would inject $[X]mln in senior secured notes if;
      2. Existing Senior Secured take a [5]% haircut
      3. Unsecured take a [15]% haircut
      4. Equity take a [50]% haircut
      5. Again, the idea would be for pre-packs to be, well, pre-done. The idea would be that if your business is hurling towards bankruptcy, it may be best to bite the bullet and recapitalize (via the US notes) while re-working your balance sheet right now. If your firm meets the FCF, EBITDA, or whatever criteria is determined then the US would offer this package automatically. Contingent only on those within the capital structure consenting to taking at least [X]% haircuts (as consent is required by law). Note: you may want to say that any financing put in – or backstopped by – the US will not be additive to the covenant ratios underpinning the rest of the capital structure (or these covenants can just be amended, if necessary, to allow for this new capital injection as is commonplace anyway).

One would hope that if The United States does something like this it could serve three useful functions:

  1. Providing confidence to market participants that there will be a financing backstop – for otherwise healthy firms blindsided by COVID-19 – by the United States, which will likely have the paradoxical affect of freeing up credit from private participants and stopping the explosion in credit spreads and the halting of credit extension we’re currently seeing.
  2. Allowing firms, without much relative credit risk to the United States, to obtain a runway through the fresh injection of capital along with a modest restructuring that will help them weather the storm if it is to be prolonged.
  3. Providing an automatic, guaranteed solution that is widely accessible to firms as all qualifications and terms would be preset and thus remove any uncertainty as to what firms would be able to qualify for or ultimately obtain.

Using the bankruptcy code in this way would allow the United States to help firms (albeit, likely slightly larger ones than mom-and-pops) in a predictable, known, guaranteed way while also protecting tax payers from taking significant downside risk positions in an ad-hoc and convoluted matter via bridge loans (if they are feasible at all, which I doubt). In short, the United States would leverage the incredibly strong institutional and intellectual framework of its existing bankruptcy code.

I believe – as I believe you do as well – that we are in for a much lengthier protraction than many anticipate…I do not believe Goldman’s forecast…that we’ll see 13% GDP growth in Q3. I do not believe demand will return so quickly or in such force, because I do not believe we will return to normalcy as quickly as we have just departed it.

As I said previously, I have no grand unified theory to get American business through this crisis. However, we both agree in the general goodness of Big Business as a driver of America. What I’ve just laid out is perhaps the most politically palpable solution (because it involves bankruptcy, even if only in name only) that can give a strong life line to those currently in need while not exposing taxpayers to absurd (albeit still large) credit risk. This solution also can be worked to protect pension liabilities and other essential worker benefits.

I think it’s inevitable that we have mass insolvencies, dislocations, and mismatches moving forward. For small businesses, there are solutions around the edges, but I simply cannot comprehend how the United States would be able to figure out and then extend the appropriate levels of credit via bridge loans en masse to these folks. It is surreal to imagine it possibly working and I worry deeply about what such a program – if tried, almost certainly with less dollars than would be required – would do to the social fabric and psyche of the American people when firms inevitably still buckle and break.

I haven’t given much thought to how to leverage the institutional framework of America to best ameliorate this crisis, but I’ve seen no one speak much about how out-of-court or in-court restructuring could be a partial solution. So I figured I’d pass this along as something to keep in the back of your mind and mull over.”

Zachary tells me you can reach him at Zachary.Booker@mail.McGill.ca.

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This makes too much sense, and thus will never happen. Who best to champion this and actually give it a shot at being considered?

Is ironic that Elizabeh Warren was a bankruptcy professor at Harvard? Heneral opinions of her, and her platform aside, I wonder if her camp has advocated for using BK.

Her position has been all over the media. She has demanded that companies maintain payroll and pay $15/hour within a year. Labor seats on the board, collective agreement remain in place, no dividends or buybacks. No mention of bankruptcy.

I believe she focused more on consumer bankruptcy costs and agency costs- leakages- money that goes to the professionals: lawyers, financial advisors and her work was quite good. To bad she fell off the reservation of rational thinking!
Bankruptcy is a field day for professionals advising troubled companies and most of this has been result of Bankruptcy Reform Act back in 1978. Also, other abuses such as paying retention bonuses to keep execs. on staff with many of these payments excessive.
Bankruptcy judges have considerable power and in recent times have pushed back re fees of professionals, just ask Weil Gotshal.

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I appreciate Mr. Booker, who appears to be a Canadian undergraduate student, sharing his thoughts. Unfortunately he also appears to have a pretty limited understanding of American bankruptcy law and practice. (As just a random funny example, nothing is "technically" called a Chapter 22... that's just a nickname for a company that goes through the Chapter 11 process twice.)

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Why fold?

It would be much easier to pay the workers 80% of their salaries from the unemployment payment fund. This reduces the amount required for company loans. Loans that could be handled through the private banking system, like in Switzerland, using government guarantees up to an amount like 1 million dollars.

The real danger is a deflationary circle, as the money needs to be in the hands of those that spend.

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Any scheme that somehow preserves the company while zapping the shareholders is in effect destroying wealth. Wealth in pension funds, private retirement positions, and so on. So while such schemes may keep companies going (and that might be a good thing) it will still make vast swaths of society poorer.

Once again, we're faced with the issue of when does more of the medicine do more harm than good? That is, at what point do the costs and damages of the shutdowns exceed the "value" of the lives they (maybe) save?

Question: Should we all agree to live in povery to add an average of 3 QALY years to 1% of the population? 10 QALY for 2% of the population?

Boomers vote. If there’s one thing we can count on it’s Boomers sacrificing the next generations on the altar of their vanity.

See also: housing markets, offshoring critical medical supply manufacturing, climate change, trillions in government debt...

Using a ratio of 1 reported case to 100 unreported cases (for which there is zero evidence from well tested countries like Germany or South Korea) less than 10% of Italy's population has been infected. Do get back to us when 3 times as many Italians as today have been infected, or if one is optimistic, vaccinated.

Using a considerably more likely ratio of 1 to 10 (or 20, for that matter), these lockdowns are a desperate attempt to stop the infection from going from 1% of the Italian population to 5%.

Everybody keeps forgetting the novel part of this pandemic, and just how recent it is, not even a half year. So after a half year, let us know how things turned out. A half year, meaning that fall will just be starting - venture to guess whether even 20% of everyone in the U.S. will have been infected by and recovered from covid-19 by then?

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As a Seattle doctor, I’m watching the slow motion economic destruction of my town. At the same time, I’m skeptical that “flattening the curve” will save many QALY since this is mostly being done to avoid overloading ICUs and we already know that ventilator-dependant ICU care is generally low value. When this is over, I would love to see an analysis of QALY saved vs. intervention cost and compare this to other interventions that we’ve refused to do that might save a similar number of QALY (e.g. banning smoking).

Aye, to quote someone else: "The solution is to do what China did, or do nothing at all. We are past the stage at which strategies like those of Korea and Taiwan would work. Either shut everything down for a month such that you can't even leave your apartment unless it's your turn to do grocery shopping for the week, or just let the forest erupt in flames and see what's left after the conflagration. What we're doing now is like building the world's most expensive submarine but leaving a hole in the bottom. The reverse of the Pareto principle: 80% of the cost of a total shutdown but <20% of the benefit."

There are massive costs to letting the disease burn. The rest of the world would have to isolate itself from our stupidity. Many business would not reopn and many employees would refuse to come back to work.

What do you think would happen if 3 million Americas die, the world stops doing business with the idiot Americans, and people start shooting their bosses for being stupid?

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See my response to Anonymous under Get Back to Us.

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Using some extremely simple math, get back to us when 10% of the people in Seattle have been infected. Which is the number one gets from Italy, with each reported case representing 100 unreported cases (a number with zero empirical evidence from well tested areas like South Korea or Germany).

Using Washington state as a proxy for Seattle (which is flawed, but adequate for demonstration purposes, and with a bit of rounding), currently there are 2000 confirmed cases, in a state with a population of 7.6 million. This means that till now, less than 3% of the people in Washington state have been infected, at a totally empirically unsupported ratio of 1 to 100.

Care to give a professional opinion of what the medical result would look like if in the next month, that number becomes 6%? Or 12% in the next 3 months?

Too fast.

If that ratio is more like 1 to 10, Seattle is not even close to a 1% infection rate.

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Is that the measure: A better one would be to compare Seattle (which did not know it had spread) to a city which intervened earlier to block the spread.

In fact, you could go a little further in the analysis:

Compare the US, which, up until now, had a good record of blocking a virus spreads early (H1N1, SARS, Ebola) to the economic costs of those countries which were unable to block early stage epidemics.

You could also argue those countries (Singapore, Korea, Taiwan) which were unable to block early stage spread in the past, and which had exposure to some of these diseases built up their social immunity by virtue of having had widespread exposure to disease and know how to deal with it and accepting that cost because they saw at the end of the day they were not dead. That made them more vigilant than they had in the past, more willing to act, accepting of social distance controls, had experience in masks, gloves, etc. when this virus arrived

This is in response to Anonymous above and not this comment.

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"we already know that ventilator-dependant ICU care is generally low value." Can you tell us more about that, explicitly, please?

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Federal money cost tax payers 2.5% (interest expense/debt including social security). Taxpayers have no interest free loans to give ,at best we get a tax deferment.

Why does Treasury still have high interest costs?
From last time when our favorite economists said interest raters were low, they were 3.5%, that was considered low. In fact, the ten year has been dropping since 1980, And we pull this stunt every time we have our regularly scheduled recession, paying high rates and telling ourselves they are low.

Also, I might note, in both cases we end up bailing out the primary dealers, the folks who manage federal cash flow because the Senate is too ignorant to do it themselves.

This all sounds like default time, the new generation is looking back at this with better tools and finding these massive boomer losses everywhere, needing default.

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Could someone with adequate understanding comment on why banks ()if we posit the Fed re-establishing, if implicitly, expectations of pre=crisis NGDP growth) could not (have the means) and would not (have the incentive) to undertake DIP lending as laid out instead of the US government.

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The solution is to select a handful of sector champions, then have the government invest in the entire capital structure of these champions to consolidate their respective markets. The end goal is that we should really only have a handful of very large systemically important and cash rich corporates.

Small business, high growth/high cash burn businesses, and entrepreneurial activity is too risky. Banning new business formation will eliminate future moral hazard.

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"I have an extraordinarily deep concern": wot larks. I know I need read no further. At least he's not truly troubled.

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Priming out of court loans have taken place during times when most restructurings and all that is needed is for lenders to see that to not go along will result in pre-pak bankruptcy being filed and they realizing Bankruptcy Jude will approval that which they declined to go along with for an out of Court solution,
The issue is not so much where the investment takes place in the capital structure; it is in determining the cash needed as the crisis unfolds.
DIP facilities are to keep the doors open and Priming loans do the same; the issue again is forecasting needs during this time period.

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Not exactly on point, but a wave of COVID driven bankruptcies will greatly reduce the access to credit hit associated with the filing a non-COVID driven bankruptcy in the relevant time period. Since access to credit impacts are a huge factor discouraging small businesses for filing for bankruptcy, many businesses that are struggling and want to reorganize or liquidate may choose to do so now.

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"Equity take a [50]% haircut"
What does that mean? Saying the value is 50% less would still leave 100% of the shares with current owners? Or does it mean that half the ownership is given to one, some, all the debt holders in some ratio?

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