The Great Deleveraging rumbles on:
The proposed deal would see Cinven's 73 percent stake cut to 65 percent and Jost's management, which owns about 27 percent of the group, would see its shareholding drop to 20 percent, two sources close to the talks said.
Holders of about 87 million euros of mezzanine debt, a higher-risk type of loan ranking further down the capital structure, would convert their claims into preferred shares, giving them a 15 percent equity stake in Jost...
With a standstill agreement with lenders due to expire in two days, fresh talks are taking place, one of the sources said. The standstill agreement, which freezes interest payments due on debts, could be extended again, removing the threat of insolvency, which is one option that has been discussed by creditors.
This is how things are supposed to work.
If the underlying business has value but cannot meet its interest payments, the lenders agree to convert some of their loans into shares. They no longer receive interest payments (which they weren't going to get anyway) but gamble on getting dividend payments in future instead. It's better to get something than nothing. Depending on the precise terms of the loan, such lenders have the upper hand in negotiations because they can threaten to put the company into liquidation (see last sentence of excerpt).
And (for the zillionth time) this is exactly how the banks could be/could have been sorted out.
A Prediction
1 hour ago
6 comments:
Is there a way for all lending to be equity-based instead of debt-based? It would sort out most of these issues before they begin. It would also mean you wouldn't need to print money.
F, it is conceptually easy for businesses to be 100% equity financed. It doesn't quite work with mortages unless you do Islamic finance, and banks would not be able to lend on your deposit (and hence not be able to pay you interest */irony*).
But that's the point about D4E, if people get their forecasts wrong, you just convert a bit of debt into equity and keep going.
I agree that debt-for-equity swaps are a great solution for this kind of deal (ie businesses that although profitable *at what they do* are over-leveraged and can't meet their interest payments). I don't think it could work in quite the same way for banks, though.
Jost's job is to make truck parts. It does this well, generates cash, has a good reputation among clients, etc.
Meanwhile, it's owned by a holding company whose job is to do whizzy financial things that are supposed allow the owners to get the maximum possible profit from Jost's truck part making, by leverage, minimising tax, and so on. This company is only of interest to its shareholders and creditors; if it was wound up tomorrow, then the administrator would sell its Jost shares to the highest bidder and Jost would carry on making truck parts as if nothing had happened.
So: 1) it's easy to work out Jost's enterprise value, and hence fair values for the debt/equity swap; 2) the fact that Jost's parent company is financially distressed won't in itself reduce Jost's value.
For banks, that split between "profitable real-world businesses" and "financial wizardry creating paper losses that don't have any real-world importance" doesn't exist. The bad crazyness was embedded deep in the system (within commercial and mortgage banking divisions, not just investment banks - this is why people who argue for Glass-Steagal to be reintroduced are daft).
So: 1) it's very hard to work out a bank's enterprise value, particularly at the time of the bail-outs, because at that point nobody knew which assets would blow up and which wouldn't; 2) if a bank is financially distressed, this directly hurts its business and deters people from using it, thus further reducing its value.
With all of this happening at all the banks at once, the situation in 2007-08 was bleak enough that the bail-outs were the only way of stopping everything from collapsing. Which would have cost far more than the (temporary and still on track to be repaid) 10% of GDP that the bailout cost.
John B: "So:
1) it's very hard to work out a bank's enterprise value, particularly at the time of the bail-outs, because at that point nobody knew which assets would blow up and which wouldn't;
2) if a bank is financially distressed, this directly hurts its business and deters people from using it, thus further reducing its value."
To 1) banks are a balance sheet exercise. At any point in time there is a quoted market value for its shares and bonds so swaps can be carried out in such a way as to minimise transfers of real value.
To 2) Sure, these swaps might take weeks or months to agree, so there's no harm in the govt giving them a bridging loan for that period. If you look at Northern Rock, what they ended up with was a convoluted kind of debt for equity swap involving two banks - all ordinary depositors were repaid in full, shareholders lost everything and bond holders took a hair cut.
If the bank doesn't have any value then the state can just print the money to give to depositors.
The bank going bankrupt will be more deflationary than printing the cash.
AC1: "If the bank doesn't have any value (1) then the state can just print the money to give to depositors. (2)"
1) That all depends whether you count 'bank bonds' as (a) a liability (in which case you deduct them from value) or as (b) akin to share capital (in which case they are a record of ownership of value).
I prefer (b).
On the whole, bank bonds are about 25% of total 'value' and even with a 40% house price crash, total bank assets would not tank by more than 20% or so. Ergo, there will always be 'value' there to be shared out among the bond holders (the new owners).
2) Yes as a stop gap, the govt could reimburse all depositors in full and then repay itself first during liquidation, which is sort of what they did with N Rock.
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