Thursday, June 25, 2020
In the coming corporate bankruptcy crisis, banks and companies perceived as bad actors in society will find their resolution terms to be very harsh. To avoid being diluted or even wiped out, large shareholders and corporate boards of directors must be constantly vigilant in exercising their oversight duties. Stakeholders must enforce policies which require company management to act in a socially responsible fashion.
Two examples of failure and resolution from the 2008 financial crisis illustrate the point.
In 2009, the US Treasury loaned $49.5 billion to General Motors in exchange for preferred stock and senior creditor status in the subsequent, post-bankruptcy resolution. As a result, the existing shareholders and bondholders were wiped out. The lesson is that GM was perceived to have been a black-hearted villain in the over-leveraging of the U.S. economy through the prior actions of GMAC, its credit subsidiary. If the voting shareholders had been more diligent in their governance duties, reining in the aggressive sub-prime lending at GMAC, it’s possible their interests would have been respected and their investments salvaged.
By contrast, the Dutch government protected shareholders of ING Groep NV when the bank was bailed out by the Dutch government in 2008. While not entirely without blame, ING was generally perceived to be a collateral casualty of the crisis, pun intended. There was no attempt to disenfranchise the existing stakeholders. In fact, the Dutch government tried to avoid dilution in the terms of the rescue effort.
Debate about the wisdom of the U.S. government’s rescue of General Motors continues to this day. Some policy makers contend that the government saved GM, while others argue that it was really the United Auto Workers Union that was saved. In a nearly contemporaneous 2012 analysis, the conservative Cato Institute said the outcome was determined by politics:
“Both GM and Chrysler were headed for bankruptcy. If they had gone bankrupt under chapter 11, most of their factories would have stayed open and they would have continued making and selling cars. Bankruptcy would have allowed the companies to avoid interest and dividend payments for a time, and to renegotiate union contracts. Under bankruptcy laws, stockholders would have lost the value of their stocks, but bond owners–who have first claim to company assets and profits–would have been paid off, if not in whole than at least in part.
“Instead of letting the companies declare bankruptcy, [President] Obama decided to “bail them out” by taking them over. Once the administration had control of the companies, it had them file for bankruptcy, just as they would have done without the government takeover. Stockholders still lost everything, but so did Chrysler’s bond holders. Instead of renegotiating union contracts, the administration gave the unions greater say over the companies. In other words, the administration didn’t bail out the companies; it bailed out the unions at the expense of (in Chrysler’s case) the bondholders.”
In an October 19, 2008 story in The New York Times, ING was said to have been “one of the world's more stable lenders” prior to the crisis, but that government “cash injections into its rival [Fortis Bank] suddenly made it look less comparatively less robust.”
ING was unable to raise funds in the market, so the Dutch government invested 10 million euros to bring its capital ratios into line with its competitors.
“The bank said structure of the transaction was intended to avoid dilution of existing shareholders. ING has the right to buy back all or some of the "core Tier 1 securities" at any time at 150 percent of the issue price. The bank said it would not pay a final dividend for 2008.”
The bailout transaction was structured in the form of nonvoting preferred shares, “giving the government an 8.5 percent stake in the bank.”
“The government will obtain the right to nominate two members for the ING Group supervisory board. The board will review executive pay for senior management "to align it with new international standards," the company said.
“The securities will pay out 8.5 percent, but only if dividends are paid over the preceding year, and will be increased annually if the dividend exceeds that rate, the Finance Ministry said in a separate statement. The structure of the deal is "an incentive to ING to withdraw from this government participation as soon as justified by the share price and the path of dividends," the ministry said.
Banks which have not enforced their risk management policies at the trading desk are seen to be negligent, while those which had simply made wrong bets were considered to be unwise or unfortunate. In either case, shareholders must exercise their governance rights or forgo any claim to the leftovers after bankruptcy.