GM, Chrysler and the Secured Loan Market
June 4, 2009
The leveraged loan market received a pleasant surprise recently when it was reported that secured lenders to General Motors were expected to be paid in full as part of GMs government-orchestrated bankruptcy. That the government officials negotiating the GM reorganization were able to appreciate the significant difference between the security position of GMs lenders and the security position of Chryslers lenders is vastly re-assuring to bankers and investors in the U.S. and Canadian secured loan markets generally, as well as, of course, to the GM lenders themselves.
The news that Chryslers secured lenders would be paid only 30 cents on the dollar had cast a pall on secured loan markets. It had been widely reported for many years that the average secured loan recovery lands in the range of 75% to 80% of principal. So when a high-profile bankruptcy like Chrysler resulted in its secured lenders being asked to accept only 30%less than half of a normal secured recoveryit attracted considerable attention and even raised questions about whether something sinister was afoot. Did the government have its proverbial thumb on the scales, some commentators asked, with respect to traditional creditors rights and bankruptcy law? Would traditional contract and security rights be respected? Or did the U.S. government have its own agenda that would prefer politically influential groups, like workers and their unions, at the expense of the contract rights of secured creditors?
Lost in some of the discussion seemed to be the more pedestrian explanation: maybe Chryslers secured creditors only deserved 30%. Although 75% to 80% is the average secured loan recovery, based on years of empirical data, the dispersion around that average is substantial. In fact, the typical secured recovery is closer to 100%, with the occasional total loss or minimal recovery (20% to 30%) dragging down the average. In many cases where the recovery is 100%, the creditors are secured by highly liquid assets (like accounts receivable) that can be turned into cash very quickly. In other cases, where the creditors do not have easily liquidated assets but still collect most or all of their loan, it is because they are able to sell or reorganize the bankrupt company as a going concern, realizing its full enterprise value.
The value of the whole, in such cases, is almost invariably greater than the value of the sum of the parts of the firm if liquidated. That may explain the vastly different repayment levels for GMs and Chryslers secured lenders. Most observers expect GM to continue as a largely intact, albeit smaller, company, thus retaining its enterprise value. Chrysler, by contrast, had it been forced into bankruptcy as a result of secured creditors sticking to their guns and resisting the government-imposed compromise, was almost certain to have been liquidated. That would mean its assets would have been sold off piecemeal, with whatever goodwill that may have once been included in its valuation lost forever.
That GMs secured lenders were in a more securely protected position than Chryslers has been clearly telegraphed in the prices of their respective loans in the secondary loan market over the past year. GMs secured loans have traded in a range of 30 to 90 cents on the dollar, most recently around 60 to 65. Chryslers, by contrast, have traded between 15 and 75 cents, most recently around 20 to 25. Based on this, it should come as no surprise that the Chrysler loan holders might have seen 30 cents as a reasonable offer, while GMs lenders would have expected, and received, a higher one.
This outcome could be re-assuring for the bank loan markets in the U.S. and Canada (Canadian banks are highly active in the U.S. loan market, and are particularly involved in the big-three auto credits) and for the credit markets generally. First, it reaffirms the value in secured loans generally, and allows Chrysler to be seen in its appropriate context, as an outlier, not as a typical secured lending result.
It also suggests what many commentators have been saying for the past year, that there is tremendous value in the loan market, given the discounts at which even many healthy, performing loans are selling. If a clearly troubled credit, like GM, is going to repay its secured lenders close to par, then that augurs well for the hidden value in the more healthy credits that are priced in the secondary market at 70 to 80 cents on the dollar, but which eventually should pay off at par. Equally important, it reassures secured lenders generally that their security positions will be protected and respectedby governments and bankruptcy courtsto the extent that the underlying collateral value actually exists.
Steven Bavaria is the managing director of leveraged finance at Toronto-based DBRS. He joined the firm in September 2007 to lead its entry into the leveraged finance rating business. Previously, he was vice president and head of Standard & Poors syndicated loan and recovery ratings group. Prior to that he spent 19 years as a corporate banker, two with Citibank, as deputy director of Citicorp Institute for Global Finance, and 17 years with Bank of Boston.