Wednesday, January 07, 2009

Doom On Wheels

I have a very quick question about the loans that the US Treasury has provided to GM and Chrysler. I was a little bored this afternoon, and mosied over to The Big Money, where the loan agreement, or at least the draft that was released to the public was described as:

"written in a strange dialect that combines corporate-speak with legalese. Like Latin, it is only written, never spoken, and people go to school to study how best to write it"

Well I like a challenge as much as the next man, although I should note that I spend certain amounts of time on EDGAR poring over such agreements, and am married to someone who has a fair bit of experience assembling such agreements. So the next man is probably GOING DOWN.

Still, the text is reasonably lucid by comparison with other term sheets I've read, possibly because it was designed for public consumption. It's only 14 pages long for each term sheet, which is fairly svelte for a document that purports to bring about the rescue and transformation of American heavy industry. There are also really prominent references to aircraft disposals and executive compensation, which most bankers really don't care that much about.

There's a fair amount of stuff about notifying the President's representatives about any major disposals, and reporting requirements, and providing a restructuring plan, and making sure that auto workers never again aspire to being anything more than lower middle-class. And then there's this line in Appendix A, where all the juicy stuff about the interest rate on the debt and the collateral for the loan is:

Financial covenants: TBD

Now to be fair to the Treasury, there's also a fat "TBD" next to the "Due Diligence Items and Closing Checklist" line. But financial covenants are important. The loans do have regular covenants that the term sheets describe as standard, to make sure that the borrower does not come up with inventive ways to channel cash (in an auto company? Preposterous!) out of the company.

Financial covenants are undertakings that the borrower will be producing enough cash to meet its obligations under a loan agreement. They're usually expressed as a figure for Earnings Before Interest Taxation Depreciation and Amortization (Ebitda), sometimes as a ratio of Ebitda or some other measure of earnings to debt or enterprise value (I dare say Mrs. Cutesome might pop up in the comments and correct me).

Still, it's a little worrying that the Treasury did not venture any kind of number, even a negative one, in putting together the term sheet. It's as near to saying there's a blank checkbook as Paulson and Co were prepared to go. But what sort of number can ever be determined that isn't hopelessly speculative and politically freighted?


At 2:47 PM, Anonymous Anonymous said...

Cutesome here. The purpose of financial covenants are to give the banks an ability to blow up a loan (i.e. call an event of default) if the borrower is not meeting certain measures of performance, such as leverage ratios, etc. The reason the TARP loans for auto companies may not have included financial covenats is that the gov't wouldn't want to blow these loans up (i.e. call an event of default) 'cause how would that help? We already know these companies suck and that giving them loans is just throwing more money into a hole.

At 8:35 AM, Blogger Gringcorp said...

Oooh, you're tough. See I was thinking that financial covenants were there as early warning systems, maybe a way to keep lenders in the loop about a borrower's operational condition. But no, it's all about blowing up loans and taking down borrowers.


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