An Analysis of Chapter 11 Reorganization Bankruptcy Relative to Corporate Debt and Equity
The American banking industry has long been a powerful force in the financing of business and commerce in the United States. Never was this more apparent or prevalent than in the mid to late 1980's. Commercial banks, investment banks, and other lending institutions financed multi-million and billion dollar transactions. Gigantic leveraged buyouts (LBO's), mergers, and acquisitions were capitalized through loans made by banks, the issuance of investment grade bonds and high-risk, high-yield junk bonds, and the raising of equity. The booming economic expansion of the 1980's required huge capitalization and in most circumstances the financing was easily provided to corporations. Most economists will agree that the LBO craze of the 1980's has been replaced . by bankruptcy and recession in the 1990's. Banks with troubled portfolios of real estate loans and highly leveraged transactions (HLT's) are lending no where near past levels. Regulatory pressures by the Federal Deposit Insurance Corporation (FDIC) and Resolution Trust Corporation (RTC) only add to this lack of lending and as a result the so called "credit crunch" exists.l Each and every large corporation has some type of capital structure, loosely defined as the liability portion of a company's balance sheet. This includes all of the debt of a company as well as its stock, or equity. The capital structure of a company is an indication of the debt and net worth of that company. When a corporation borrows money from a bank, the loans are almost always the most senior debt of the corporation. This means that the loans are of the highest priority in terms of the company's debt. They are of the greatest priority because banks that are in a position to loan significant amounts of money to a business require a lien - an interest in the borrower's assets securing the repayment of a debt - as a condition for a loan. Because banks are the primary entities that can lend hundreds of millions of dollars to a corporation, a company values its bank debt as the most important of all its debts. Bank loans are not the only debt that is considered senior debt although it is the most common type. Leases can be considered senior debt as well, providing that the lessor secures them much in the same way as the banks do with their loans. The next level of corporate debt is called subordinated debt, or sub debt. It is called sub debt for obvious reasons. It does not have the priority of senior debt and is not secured by a lien on the assets of the debtor. Sub debt consists primarily of bonds, often called notes, but can include debt to trade creditors, suppliers, as well as unsecured leases. Sub debt, added to the senior debt of a corporation, results in the total debt of a company. The last part of the company's capital structure is the equity, or net worth. Equity is the net value of a company, its assets less its liabilities. It is the value of the stock of a corporation. Technically, all subordinated debt and equity must be completely absorbed before a senior secured lender loses any of its principal. If a company is liquidated, the senior creditors have the first liens on the assets of the company. Accordingly, bank debt offers the most secure type of corporate debt in the market, followed by subordinated debt and then equity.4 With the massive levels of borrowing that occurred in the 1980's, banks and sub debt holders found their credits not being properly repaid. Consequently, America saw a number of bankruptcies in the 1990's. Many of the LBO's and HLT's of the 1980's have filed for Chapter 11 Reorganization Bankruptcy. This type of bankruptcy is the dominant type for most large businesses. Chapter 11 Reorganization Bankruptcy is one type of bankruptcy that falls under the United States Bankruptcy Code. Chapter 11 is, as is bankruptcy in general, a declaration by any legal entity (or person) that its debts have become unmanageable, that it has been judged legally insolvent, and that it needs to protect its assets from its creditors. Corporations file Chapter 11 with the idea in mind that the business, once it gains temporary relief from paying its debts (both senior and subordinated), will be able to reorganize successfully, pay off its creditors at least partially, and emerge from bankruptcy protection as a viable business. There are a number of steps involved in a Chapter 11 Reorganization Bankruptcy. First, bankruptcy is filed voluntarily by a troubled corporation or forced upon it by its creditors who want payments on their outstanding credits. The company is then known as a "debtor in possession", meaning that it is under bankruptcy protection but can still run and operate the business free of outside influences. The debtor then files schedules of its assets and debts letting creditors know exactly what it has and what it owes. Shortly following is the first of many creditor meetings as the senior debt holders, sub debt holders, and shareholders form their respective committees and file their claims, which are deemed as reasonable or unreasonable by the bankruptcy judge. The debtor then files a "disclosure statement" that describes its financial condition, gives an explanation as to why the debtor filed bankruptcy, and explicates the reorganization plan it will attempt to execute. The disclosure plan must meet the court's approval or needs to be altered sufficiently so as to get an approval. When this occurs the bankrupt can then formally file a reorganization plan under Chapter 11. Next, the reorganization plan is analyzed by the creditors and shareholders and their approval or rejection of the plan is rendered. If rejected, the court decides if the plan is adequate and should be carried out, or it instructs the debtor to change the plan to better suit the creditors. If the creditors and shareholders approve of I the reorganization plan, the court will confirm the plan, closing the case and allowing the debtor to emerge from Chapter 11 leaving it to follow its stated plan. What will follow in Section I is an analysis of the senior debt, subordinated debt, and equity of three companies that have filed for Chapter 11 Reorganization Bankruptcy and have emerged from it - Federated Department Stores Inc., G. Heileman Brewing Company Inc., and Greyhound Lines Inc.. How their respective bankruptcies affected these three levels of each company's individual capital structure will be explored in detail. Various financial numbers and statistics of each company will be discussed in the analysis process. Finally, thoughts as to possible benefits and drawbacks of the reorganization plan relative to each level of the capital structure will be offered. Section II will discuss the type of work undertaken during my WESIP. It will include materials reflective of the kind of work performed at Park Capital as well as information on a specific deal that is typical of Park Capital's daily business routine. Section III will integrate the experiences realized at Park Capital during my WESIP with previous academic work. How classroom subject areas were tied into the WESIP will be explored in detail. Finally, long-term career goals will be discussed relative to my experiences at Park Capital during my WESIP.