[marvin]

Bankruptcies or stock offerings at crisis prices would help too. For instance, the airline Norwegian just accepted 95% dilution of existing shareholders in order to qualify for a government emergency loan. If they'd refused this, they would have gone bankrupt.

Some shareholders were expecting a government bailout, and got a real beating. They're going to think twice about expecting a government bailout the next time.

[remarkEon]

I don't know that I see 95% dilution as totally reasonable terms for a bailout (though I know absolutely nothing about the details of that example), but making it clear that bailouts come with a cost seems like a good development ... so good on the Norwegian government for doing that.

[marvin]

Why do you consider that unreasonable, when the free-market option is bankruptcy? They got to keep 5%, rather than 0!

The terms of the emergency loan was a certain debt:equity ratio, so in order to qualify, their very high debt load had to be reduced.

This could be accomplished in any way the company desired, and it turned out that the only viable pathway was to allow bondholders to convert their loans to new shares at a favorable price. This led to a 95% dilution for existing shareholders.

If they hadn’t done this, proper bankruptcy would have been the next step.

[zdkl]

I wonder why this mechanism (converting potentially derelict bonds into equity) isn't more widespread. In cases where the underlying company reasonably could be expected to continue operating were its debt ratio lowered, apart from legitimate resistance of bondholders expecting debt+interest payments why wouldn't this outcome be preferred to bankruptcy?

[marvin]

Perfectly agree that this is preferable to bankruptcy. I might have worded myself ambiguously -- the emergency government loan might be a sort of bailout, but it wasn't a gift to the shareholders. When I hear bailout, I normally expect the latter.

The government is expecting the loan to be repaid, and to make that expectation likely, they're requiring the company to use market mechanisms to strengthen its balance sheet. The result in this case is that existing shareholders are practically wiped out.

In the case of Norwegian, this is pretty clear-cut. They've been on the verge of bankruptcy before, and their losses now are mostly due to foreign routes shutting down. Even if you accept the somewhat dubious rhetoric that compensation is mandated when losses are partly due to government involvement, it doesn't apply to this case. There was no way they could service their debt during the Covid crisis.

Some sharehoders were expecting the government to give an unconditional loan to be defaulted on later, or participate in a stock offering at prices high enough to preserve their ownership percentage.

This is an unequivocal message to shareholders not to expect that sort of rescue operation in the future. Run your company with a debt ratio that will let you survive unexpected hardships, or accept the risk of facing such hardships on your own.

[kgwgk]

This is actually one of the possible outcomes of bankruptcy. The business may be liquidated but it's not the only option. There may be a restructuring and creditors may become the new shareholders after the orginal shareholders are (in most cases) wiped out.

[PeterisP]

IF "the underlying company reasonably could be expected to continue operating were its debt ratio lowered". That's always debatable, and even moreso in the current economic circumstances - I would not be certain that some airline will be able to return to profitability any time soon.

It makes all sense that a bondholder may calculate that liquidating the company and selling off the assets will allow them to recover more of that debt than having the company continue operating. If so, bankruptcy is preferrable - and if others disagree and believe that the company will be profitable, the bankruptcy process allows various ways that essentially allow the "believers" to gather funding to pay off/buy out "unbelievers".

[drumhead]

The banks or debt holders dont necessarily want to become shareholders. It the most junior type of debt, and they're reliant on the company recovering, which may not happen. They could be left holding shares for years before it makes a return.

[firebird84]

In the US creditors have liquidation preference in bankruptcy. You give that up if you convert to shares but gain some measure of control if the company is still solvent. It's a tradeoff I'm guessing. It's possible they have more to gain in bankruptcy in certain cases.

[remarkEon]

Well now that I know it was a binary choice, yes taking the 95% dilution seems like the best option without knowing anything else about that company's financials.

[appleflaxen]

bankruptcy isn't necessarily zero, but for a highly leveraged company it probably will be.