Posts tagged ‘bankruptcy’
Bankruptcy: Where are You on the Capital Structure Totem Pole?
The media likes to focus in on the microscopic universe of 30 stocks we like to call the Dow Jones Industrial Average, or the “market.” The reality is the Dow is like a drop in the ocean if you consider the global opportunity set across the capital structure. What is the capital structure? Well, you can think of the capital structure like a totem pole. The actual universe of investment opportunities spans everything from Blue Chip dividend paying stocks to illiquid international convertible preferred securities. The selection of the security type will determine where you sit on the capital structure (totem pole), and the location is especially important when the topic shifts to the dreaded word…B-A-N-K-R-U-P-T-C-Y.
Opening the Chapter Book on Bankruptcy
From a security or safety standpoint, the preferred investor location is at the top of the totem pole (capital structure). Why? Because once an entity declares Chapter 7 and begins asset liquidation, the bondholders/creditors at the top of the structure get paid first – whereas the equity holders at the bottom of the pole get paid last (if there are any asset proceeds remaining to be distributed). Here is a general ranking, from top to bottom, of the major security categories along the capital structure (more specialized hybrid security versions can fit in between the listed items):
1) Secured Bonds
2) Unsecured Bonds
3) Convertible Bonds
4) Preferred Stocks
5) Common Stock/Equity
Bankruptcy is a legal process that provides relief to many individuals who can no longer pay all of their debts. A potential outcome in the bankruptcy process is “debtor discharge,” which wipes away some or all of an individual’s debt. Here is a brief synopsis of the bankruptcy flavors:
Chapter 11: Designed primarily for businesses, Chapter 11 bankruptcy law allows financially distressed businesses to remain in business as debt payments are reorganized under the supervision of the courts. Technically, individuals can also choose to file for Chapter 11 bankruptcy, however practically speaking, individuals generally choose other paths. High profile examples of Chapter 11 bankruptcies include Lehman Brothers, Enron Corp., WorldCom Inc., General Motors Co., and Chrysler Group.
Chapter 7 & 13: These segments of the bankruptcy code are principally constructed for individuals. A means test reviewing an individual’s financial situation will determine which plan is most feasible. Here are brief descriptions:
- Chapter 7 is often referred to as the liquidating bankruptcy. This bankruptcy strategy is often used by individuals to save assets like a home and/or car. Although non-exempt assets will be liquidated by the owner to pay off creditors, many of a debtors assets are categorized as exempt – meaning the owner will not be forced to sell assets and creditors are held at bay.
- Chapter 13 allows individuals to retain assets by following a court sanctioned payment plan. Typically debt payments are made by the individual over years, and as long as payments remain current, the owner can retain assets.
More to Gain, More to Lose at the Bottom
Being at the bottom of the capital structure totem pole (owning stocks) involves relatively more price volatility. If you combine the wild swings with the fact that about 50% of households own stock in some shape or form (Edward N. Wolff at New York University – 2009), then you create a recipe of intrigue. Theoretically, stocks have unlimited profit potential (not the case for most bonds). The media loves to report on the daily fortunes won and lost on the global stock exchanges, in addition to following the bigwig billionaires.
More Boredom, Less to Lose at the Top
Being at the top of the capital structure totem pole (owning bonds) comes with more security (less volatility), but also more boredom (less profit potential). That’s not to say healthy returns cannot be achieved in the bond market. We saw firsthand, during the financial crisis, how bankruptcy fears rocked certain areas of the bond market (e.g., high yield bonds), creating extraordinary investment opportunities. With liquidity returning to the market, and signs of economic stability coming back, investors will need to climb much higher up the tree to grab the hanging fruit.
Although there is plenty of room for optimism given certain macroeconomic and corporate indicators, the global economy is certainly not out of the woods. Business bankruptcies remain elevated, just as investors are piling into the perceived safe arms of corporate bonds. Interest rates, along with industry and company-specific factors will obviously impact the price performance of corporate bonds. If the economy hits choppy waters again, it behooves investors in higher yielding bonds to get a better understanding of where they sit on the capital structure totem pole. If not, those bond investors will slide down the capital structure, left commiserating about losses with their neighboring risk-loving stockholders.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing had no direct positions in Lehman Brothers, Enron Corp., WorldCom Inc., General Motors Co., and Chrysler Group or any security mentioned in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Bashful Path to Female Bankruptcy
The unrelenting expansion in bankruptcies does not discriminate on gender – you either have the money or you do not. Naomi Wolf, author of Give Me Liberty: A Handbook for American Revolutionaries, recently shed light on the underbelly of those suffering severe financial pain in this economic crisis…middle-class women.
How bad is it for middle class women?
“A new report shows that a million American middle-class women will find themselves in bankruptcy court this year. This is more women than will ‘graduate from college, receive a diagnosis of cancer, or file for divorce,’ according to the economist Elizabeth Warren.”
Wolf explores multiple factors in trying to explain this phenomenon. Surprisingly, higher education levels does not appear to prevent a higher percentage of bankruptcies in this large demographic.
If education levels are not a contributing factor, then what is? Here are some Wolf’s findings:
1) Awash in Debt: One explanation for the extra debt reliance is many of these positions occupied by this class of women are lower-paying, which requires women to tap credit lines more frequently. Also, many women have been targeted by luxury-goods manufacturers and credit-card companies. Repeated contacts by the marketers have led to more women succumbing to the consumerism messages shoveled to them.
2) Credit Card Legislation: Wolf makes the case that financial credit card legislation introduced in 2005 disproportionately negatively impacts divorced wives because credit card companies get priority in the repayment line over critical child support payments. In other words, child support payments go to the credit card company rather than to the child, thereby creating an undue financial burden on the female caregiver.
3) Skewed Emotional Beliefs about Money: The biggest issue regarding the emotional connection to finances is working-women “find it embarrassing to talk about money.” The article even acknowledges that many current generation women earn more than previous generations, but financial security has largely not improved because of the “money taboo.” I discover this taboo dynamic in my practice all the time. Part of the blame should be placed on the financial industry’s use of endless acronyms as smoke and mirrors to confuse and intimidate clients on the subject of money. I believe the better way to financial success is to empower clients through education and understanding, not deception and misinformation.
Wolf goes onto explain some of the confused financial thought processes held by this segment of women:
- Negotiating salary increases is difficult for these women because it makes them feel “unfeminine.”
- This class often fails to save because they falsely assume marriage will save them financially.
Unfortunately, the lack of financial literacy and dependence on the spouse leaves these women vulnerable to divorce and widowhood.
Working Class Women Better Prepared
Interestingly, Wolf’s findings point to working class women being much more financially literate and prepared in part because they have erased the notion of a knight in shining armor saving the day from their financial responsibilities. Bolstering her argument, Wolf references the success of the micro-finance programs being instituted to lower-class, working women in developing countries.
Wolf’s Solution
How do middle-class working women break this negative financial cycle? Wolf delivers the medicine directly by directing these women to break the “social role that casts middle-class women as polite, economically vague, underpaid, shopping-dazed dependents.” Opening their eyes to these issues will not erase all of the contributing factors, but women will be better equipped to deal with their financial problems.
From my perspective, there is no quick fix for immediate financial literacy. For those interested in learning more, I encourage you to read my article on personal finance, What to Do Now? Time to Get Your House in Order.
Regardless of your financial knowledge maturity, like any discipline, the more time you put in to it, the more benefits you will receive.
Read Complete Naomi Wolf Article Here
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at time of publishing had no direct positions in any company mentioned in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
The Hidden Train Wreck – Professional Athlete Portfolios
Need capital for a floating furniture venture? How about an oxygen absorbing skin procedure? Well, if you are having any difficulty, just call an NFL, NBA, or MLB rookie. Even wealthy professional athletes have been impacted by the financial crisis, not to mention the aggressive sales tactics of the investment industry and the players’ poor money management skills. Many players are too busy concentrating on winning games, while their portfolios are suffering losses. The statistics are staggering. Here are the findings, according to an article published in Sports Illustrated earlier this year:
- “By the time they have been retired for two years, 78% of former NFL players have gone bankrupt or are under financial stress because of joblessness or divorce.”
- “Within five years of retirement, an estimated 60% of former NBA players are broke.”
- The divorce rate for pro athletes ranges from 60% to 80%, based on estimates from athletes and agents.
- “According to the NFL Players Association, at least 78 players lost a total of more than $42 million between 1999 and 2002 because they trusted money to financial advisers with questionable backgrounds.”
These are not old, dementia-suffering widows living in Florida we are talking about, but rather professional athletes, many of which made multi-million fortunes during their playing careers. The article goes out of its way to demonstrate this is not a fringe issue affecting a minority of professional athletes. Numerous examples were provided, including the following:
- Ten current and former Major League Baseball players, including outfielder Jonny Damon of the New York Yankees, had some of their money tied up in the alleged $8 billion fraud perpetrated by Robert Allen Stanford.
- Raghib (Rocket) Ismail lost a fortune by investing in excessively risky ventures, including a movie about music label COZ Records; a cosmetics procedure company; a nationwide phone-card dispensing venture; and a framed calligraphy company opened in New Orleans two months before Hurricane Katrina hit.
- Drew Bledsoe, Rick Mirer and five other NFL retirees each invested a minimum of $100,000 in a failed start-up, which touted “biometric authentication” technology that potentially could replace credit cards with fingerprints. The players eventually sued UBS (the financial-services firm) for allegedly withholding information about the company founder’s criminal history and drug use.
- Torii Hunter, outfielder for the Los Angeles, invested almost $70,000 in living-room furniture that included inflatable rafts – perfect for those consumers living in flood zones. Suffice it to say, the results did not meet initial expectations.
- In addition to his legal problems, NFL quarterback Michael Vick filed for Chapter 11 bankruptcy last year partly because he could not repay about $6 million in bank loans that he directed toward a car-rental franchise in Indiana, wine shop in Georgia and real estate in Canada.
- Retired NBA forward Vin Baker’s seafood restaurant in Old Saybrook, Connecticut, was foreclosed on in February 2008 due to nearly $900,000 in unpaid loans.
- “NBA guard Kenny Anderson filed for bankruptcy in October 2005. He detailed how the estimated $60 million he earned in the league had dwindled to nothing. He bought eight cars and rang up monthly expenses of $41,000, including outlays for child support, his mother’s mortgage and his own five-bedroom house in Beverly Hills, Calif.—not to mention $10,000 in what he dubbed “hanging-out money.” He also regularly handed out $3,000 to $5,000 to friends and relatives.”
- “Former NBA forward Shawn Kemp (who has at least seven children by six women) and, more recently, Travis Henry (nine by nine) have seen their fortunes sapped by monthly child-support payments in the tens of thousands of dollars.”
Besides irresponsible spending, and greedy advisors, contributing factors to all the losses are the “boring” and “unintelligible” nature of securities investments. Professional athletes like to flaunt investments like night clubs and car dealerships – there is a “thrill of tangibility,” according to SI writer Pablo Torre.
Professional athletes are not the only ones suffering losses. Ordinary investors have lost also and are learning it’s not what you make – rather it’s what you preserve and grow. The majority of the athletes do not realize their peak earnings years cover a very brief period, and therefore need to be more prudent with their money management since the windfall moneys must be spread over many years.
Trust is an important but difficult trait to find for many of these athletes since many opportunistic friends, acquaintances, and family members in many cases put their self interests ahead of the professional athlete’s needs. There is no simple formula for intelligent money management, however there are ways for athletes to protect their financial blind spots:
1) Educate Themselves. Learn the basics of what you are investing in. You may not learn the ins and outs but you can get a basic understanding of the expected return and volatility of your investments. Athletes often forget about diversification as well, “Chronic over-allocation into real estate and bad private equity is the number one problem [for athletes] in terms of a financial meltdown,” Ed Butowsky of Chapwood Investments says.
2) Trust But Verify. Ronald Reagan famously made those statements decades ago and the principle applies to money too. Many athletes pay tens of thousands of dollars for investment advice, so asking questions is advisable. Specifically, ask how performance is trending versus comparable benchmarks and get a view over multiple time periods.
3) Avoid Friends and Family. If possible, separating business from friends and family is a wise idea. When emotions mix with money, harmful decisions can damage the athlete’s financial future.
4) Determine Fees & Commissions. When investing hundreds of thousands, if not millions of dollars, fees and commissions can be substantial; therefore it is imperative for the athletes to know what they are paying their advisors.
5) Experience Matters. Check out the background of your advisor and determine the licenses and credentials they hold. If you were flying a plane in a heavy storm, you would want an experienced pilot flying the plane, not a flight attendant.
6) Budget. Establish an investment plan with a sustainable lifestyle that accounts for inflation. As veteran agent Bill Duffy says, whose clients include Suns guard Steve Nash and Nuggets forward Carmelo Anthony, “A pro athlete’s money is supposed to outlive his career. Most players never get that.”
Athletes spend their whole lives trying to make the professional ranks in order to earn the big bucks. Due to their high profile status, financial advisors and trusted individuals prey on the sports figures’ wealth. Unfortunately a majority of the athletes lack the money management skills and discipline to preserve and grow their earned wealth. Perhaps repeatedly shining a light on the dirty under-belly of this tragic problem will prevent future financial train wrecks from occurring. Until then, I guess we’ll just have to sift though the bankrupt remains of inflatable sofa raft companies and liquidation proceeds from failed night clubs.
Read the Complete Sports Illustrated Article Here
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
Is Trump’s Business Better than His Hair?
Should Trump's Hair or Business Acumen be Fired?!
Fiery debate still swirls around the authenticity of Donald Trump’s hair (piece), but what about his business acumen? Just this year in February, Trump Entertainment filed for Chapter 11 bankruptcy. Maybe “The Donald” should be “fired?!”
If this was his only economic fatality in Trump’s career, one might cut him a little slack. I however am not enslaved into his glorified status in the media and press. My critical eye lacks the generosity necessary to honor him a free hall pass. When looking at Trump’s career, the tabloids must not forget that Trump’s Taj Mahal Casino was also run into bankruptcy purgatory in 1991. Number #11 must be Trump’s magic number because in less than a year, Trump filed for Chapter 11 on the Trump Plaza Hotel and Casino and Trump’s Castle (March 1992).
Like an infomercial, “But wait, there’s more!” In November 2004, Trump Hotels & Casino Resorts Inc. filed for Chapter 11 bankruptcy. This company reemerged out of bankruptcy as a new operating company, Trump Entertainment Resorts Inc., only to…you guessed it, file bankruptcy again. I think I see a pattern here.
With the vast bankruptcy experience Trump holds and with him and his daughter Ivanka Trump quitting from Trump Entertainment earlier this year, Donald is now trying to scoop up this company for a $100 million steal. The bankruptcy court and creditors will determine if it’s a fair deal. If not approved, rest assured, Donald will have an extra $100 million to spend wisely – possibly building another company into bankruptcy failure or perhaps…better hair care?
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
GM Fatigue Setting In
Yaaaawn. Sorry to be cold-hearted and insensitive, but I have to admit all this bankruptcy car talk is making me tired and fatigued. According to the Associated Press, General Motors is cutting 21,000 jobs in North America, about 34% of the total workforce – these cuts include pending dealership, plant, and warehouse closings. Twenty-one thousand certainly is not a minor number, but how do you think the other 6,000,000 Americans feel who have lost their jobs in this economic recession since the beginning of 2008?
Chart Source: The Economist
Don’t get me wrong, I like every other American do not want to see our historic industry vanish into thin air, but as the chart above shows, we have been witnessing this slow motion train wreck developing for decades. Detroit’s combined market share in 1980 was around 75%, and today that share amounts to less than 50%…ouch. Our auto industry needs to become more competitive, and to do so will require tough decisions like the ones being made today.
Does $65 billion in government bailout feel right? Definitely not, especially vis-a-vis the industry track record of government bailouts (i.e., 1980 Chrysler lifeline). History and current industry trends tell us that the odds of taxpayers earning any reasonable return off our bailout contributions will be extremely challenging to salvage.
Politics and votes always play a role when large numbers of jobs are impacted by government decisions, and this case has proved no different. On the flip side, nobody can say the automakers are not suffering tremendously from this bankruptcy solution. I truly believe the surviving entities will be much leaner and meaner to compete in this dog-eat-dog global economy. Sacrifices have been immense, but we’ll never know the true net economic effect had the administration not bestowed the billions and billions upon this selective slice of industries.
Money goes where it is treated best, and I would have preferred seeing the capital naturally migrating to its most productive use. Perhaps the $65 billion could have provided 65,000 different companies access to $1,000,000 each in financing for creative, and innovative job creating purposes? Only time will tell if our billions in taxes were properly used, but in the mean time I’m going to turn off the CNBC car debate and take a nap. Zzzzzz….
Investing Caffeine 
