Threatening to file for bankruptcy is a good way to get the attention of your lenders — it makes them that much more likely to agree to restructure your debts, just because bankruptcies are expensive, time-consuming, and unpredictable things. But how much money do you need to owe before your lenders will take you that seriously? In Kent Swig’s case, the number seems to be $28 million:

Developer Kent Swig is close to filing personal bankruptcy because he can’t afford to pay a recent $28 million judgment on his defaulted Sheffield57 condo conversion project in Midtown.

“We are exploring all options,” one of Swig’s advisers told The Post. “No one wants to do it but it’s certainly a play on the chessboard that we are considering at this time.”

I think most people are likely to be a little disgusted, when reading such a quote, that an extremely wealthy man like Kent Swig would cavalierly consider bankruptcy to be little more than “a play on the chessboard”. How come he gets to play chess with bankruptcy filings, when for the rest of us such a filing is ruinous in many ways? It’s just another way that the rich are different from you and me — and it reinforces my belief in some kind of wealth tax.

The implosion in the enterprise value of Reader’s Digest is astonishing — from $3.8 billion two years ago to somewhat less than $1 billion now, depending on how much the equity of the new company will be valued at when it emerges from bankruptcy, and assuming, generously, that the new debt is valued at par. Chelsea Emery talked to lawyer Richard Mikels:

“One way to deleverage is by turning debt into equity. That will happen more and more throughout the economy over the next several years,” said Mikels.

That’s true. On the other hand, when private-equity shop Ripplewood bought the magazine company for $1.6 billion in 2007, layering on $2.2 billion in debt, the simple debt-to-equity ratio was 1.375 — not enormous. The new Reader’s Digest will have $550 million in debt, which means that if the equity is worth less than $400 million, it will actually be more levered than the old, height-of-the-credit-bubble deal.

So what is the enterprise value of Reader’s Digest? In the 12 months to March 31, it had Ebitda of $280 million, which sounds impressive until you notice that the number is made up of a $995 million net loss, plus $1.24 billion in “adjustments”. In other words, it’s useless. If you look at the slideshow for the most recent quarter, you’ll see some more useful numbers. Revenues were $479 million — down 17% year-on-year. “Product, Distribution & Editorial Expenses” were $207 million, down 15%; “Promotion, Marketing & Administrative Expenses” were $270 million, down 19%; and the operating loss for the quarter was stable at $7 million.

In other words, Reader’s Digest isn’t making money even with zero debt, let alone $550 million, and it wasn’t making any money a year ago, either. How much money would you pay for the privilege of losing $7 million a quarter before interest payments?

It’ll be interesting to see where the market values that $550 million in new debt: I suspect it’ll be somewhere less than par, depending on what kind of coupon it carries. And I suspect too that the value of the equity will be rather less than $400 million. Nothing’s really changing at this company: there’s no talk of layoffs, or closing unprofitable properties, or anything like that. The owners have an interest in keeping the company big, because that’s the only way it’ll ever be able to pay off $550 million in debt. Essentially, they’re keeping the company’s embedded leverage, and buying themselves an option: if the advertising market takes off, then the new, leaner Reader’s Digest could become very profitable very quickly.

But that’s not the base-case scenario: print media is hardly a growth industry these days. So don’t be too surprised if this isn’t the last we hear about this particular company’s troubles.

Are you confused by the WSJ article about the Federal Reserve and Extended Stay? If so, then this story, filed in June by Tom Hals of Reuters, might help give some much-needed background. Even then, though, this is a very complicated and messy bankruptcy, so I just phoned Tom to get things clearer still. Here’s how I understand the situation — with the caveat that, as I say, it’s very complicated and messy, and I’m not an expert on this by any means.

First, the fact that Maiden Lane owns a large chunk of Extended Stay debt is not really news: the Maiden Lane lawyer was extremely vocal in the public bankruptcy hearing that Tom attended. (This bankruptcy is being litigated in the Southern District of New York, not in Delaware, which is a good indication of how big and important it is.)

Secondly, if you look at Extended Stay’s bankruptcy filing, something very interesting pops out: there’s substantially only one creditor. M&T Trust Co is owed $8.5 billion by Extended Stay, and that’s basically all of Extended Stay’s debt. M&T Trust Co, of course, doesn’t own all that debt: it was poured into a special-purpose entity, tranched up, and sold off to a large number of real-money creditors. It’s those creditors who are now fighting and suing each other over what happens to Extended Stay.

The senior creditors — Cerberus and Centerbridge Partners, as well as Wells Fargo, Bank of America, and US Bancorp — control a majority of the debt and have come to an agreement with Extended Stay’s CEO, David Lichtenstein whereby they essentially take over the company, leaving the junior creditors (including Maiden Lane) with nothing. Already, at least one junior creditor has written its holding down to zero.

If this were a normal bankruptcy, a majority of the creditors (the senior creditors own about 60% of the debt) might well be able to push that kind of a deal through. But this isn’t a normal bankruptcy, because technically you can’t have a majority of the creditors when there is only one creditor and that creditor is a special-purpose entity.

If the rules for special-purpose entities apply here, then the holders of the various tranches would need near-unanimous agreement, and the senior creditors couldn’t push through their deal.

The Federal Reserve does have a conflict here. As a regulator, it wants to help set ground rules which make CMBS workouts as predictable and transparent as possible. As a creditor, however, it is very much on the side of the junior creditors. To some degree it helps that the management of the Maiden Lane portfolio has been outsourced to Blackrock. And I doubt that Fed policymakers would let one $900 million note affect their prescriptions for systemic change overmuch — especially when JP Morgan has promised to eat the first $1 billion of losses on the Maiden Lane portfolio. But if you’re confused what the nub of the WSJ story is, that’s it.

There’s a subplot, too, concerning a “bad boy” clause in the Extended Stay debt, under which Lichtenstein should by rights be on the hook for $100 million now the company has declared bankruptcy. If the senior creditors get their way and manage to take over the company, however, it seems that they’ve promised to cover all such expenses — rendering the clause largely moot as far as Lichtenstein’s net worth is concerned. As the Fed looks at this case, it’ll not only be thinking about how the rules governing special-purpose entities affect property-company bankruptcies; it’ll also be thinking about whether and how bad-boy clauses should be enforced.

So you can reasonably expect this one to drag on for a while.

What are the chances of this CIT deal actually preventing a bankruptcy filing, rather than just delaying it for a few months? At first glance, it would seem that the chances are good: why else would bondholders throw $3 billion of good money after the bad money they’ve already invested? But at second glance it’s not so simple: that $3 billion in new funding not only carries a double-digit interest rate, but is also secured by a whopping $10 billion in assets.

Consider the $1.1 billion of CIT debt which is coming due in August. Those bonds were changing hands last week at an extremely steep discount, which means that many of the current bondholders bought them at 50 or 30 or even 10 cents on the dollar. For those bondholders, this deal is a no-brainer. They’re advancing CIT enough money to pay off the August bonds in full, which means that they get to double their initial investment right there. They’re getting more than 10% interest on the money they’re lending. And they’re massively overcollateralized on that money, too, which means that their recovery given default is almost certain to be 100%. Add it all up, and you’re looking at a very high return for very little risk.

So where does that leave CIT? For one thing, it leaves the lender with no unpledged assets at all, which is not a position any financial institution likes to be in. But more to the point, the $3 billion is going to run out very quickly, some time in the first quarter.

Over the rest of this year, CIT is going to have to embark upon a series of debt-for-equity or debt-for-debt swaps, all designed to take out a huge chunk of those monster first-quarter maturities and allow the company time to start making money again. But it’s not clear why CIT’s bondholders would particularly want new equity or longer-maturity debt. And the one asset which Jeffrey Peek had to play with until this weekend — those $10 billion in unpledged assets — is now spoken for.

This deal makes sense for the lenders, then, and at worst delays the inevitable for CIT. But it’s still far from clear that the private sector is capable of putting together a lasting solution to the problem of a leveraged financial institution facing a massive liquidity crisis.

If CIT really has dodged a bullet here and avoided bankruptcy, that’s spectacularly good news. I’m assuming here that a deal has done, based on nothing but a single one-line headline on WSJ.com; these things tend to be fraught and fractious, however, so I’m not counting my chickens just yet. But if CIT has really avoided bankruptcy, that’s a major turning point in the history of the financial crisis.

It’s good news for various individual constituencies, of course, especially all the small and medium-sized businesses which will now find it easier to roll over their loans. It’s good for CIT’s shareholders, who might be left with something more than $0. It’s good for CIT CEO Jeffrey Peek, who did his best Dick Fuld impression over the past few months, refusing to raise capital even as everybody else was taking any capital they could get, and as a result almost sent his company the way of Lehman. And it’s spectacularly good news for CIT’s bondholders, who could well see the value of their holdings rise from the single digits into the high double digits as soon as the markets open.

Most of all, however, it’s good news for the system as a whole, which seems to have demonstrated that it’s possible, if not easy, for a private-sector alternative to bankruptcy to be worked out without government interference or guarantees.

I have to say that on Friday, I didn’t think such a thing possible. But with CIT’s unsecured bonds reportedly trading at less than 10 cents apiece on Friday, it was clearly in the large bondholders’ best interests to do some kind of deal, even if doing so meant other bondholders would get a free ride.

The point here is that there is almost nothing which can destroy as much value overnight as the bankruptcy of a financial institution. There were questions over CIT’s solvency, of course. But we’re talking a few billion dollars of shortfall on an $80 billion balance sheet: if capitalism worked the way it’s meant to, then maybe shareholders would be wiped out, but bondholders’ recovery would be high.

But financial-company bankruptcies don’t work that way, as we saw with Lehman Brothers, liquidating a bank is a sure-fire way of getting such low prices for your assets that even secured bondholders start worrying; unsecured bondholders are liable to walk away with little if anything.

It makes sense, then, that those unsecured bondholders would have every incentive to come to some kind of deal with CIT. The problem with any deal done outside bankruptcy court is that any creditors not taking part in the negotiations are going to have to be paid off in full. In turn, that means that the bondholders who are in negotiations are going to have to provide new money, so that CIT has the cash to service its debts. And no one likes throwing good money after bad, especially when that new money doesn’t have the protections afforded to DIP financing in a bankruptcy situation.

If bondholders managed to overcome all those obstacles over the course of the weekend and come to a deal which saves CIT, then maybe the market is starting to be able to work things out on its own, without the need for government involvement. And maybe spreads on bank debt in general will continue to tighten in, as the expected recovery in case of distress rises from the single digits to something much higher. I do hope this deal happens.

Update: The WSJ article is now up:

The deal, which was being considered by CIT’s board Sunday night, charges CIT very high interest rates, and it doesn’t permanently fix the company’s long-term financing needs, say people involved in the transaction. But it buys time for the lender to restructure itself, and minimizes bondholders’ losses. Bondholders calculated they would lose more if CIT filed for bankruptcy and sold assets at fire-sale prices than if they offered the rescue.

Micheline Maynard has a good 1,000-word article today on the surprising fact that both GM and Chrysler managed to exit bankruptcy in record time. But who or what should get the credit? Steve Rattner? The two judges involved? Section 363 of the federal bankruptcy code? And is this a heartening precedent for the wave of future bankruptcies which seems inevitable when all those leveraged loans mature over the next four or five years? Or is it a one-off, linked to extreme levels of government involvement, which is unlikely to be repeated?

The Detroit News today bellyaches about how the Chrysler bankruptcy deal “may make raising cash more difficult for companies”. I have no idea where they got this idea, but it’s ludicrous. As the WSJ story on gadfly lawyer Thomas Lauria notes, Chrysler’s secured creditors are getting significantly more out of the existing bankruptcy deal than they would without the government throwing in its billions.

The fact that unsecured creditors (the UAW) are getting some recovery from the Chrysler bankruptcy even though secured creditors are taking a haircut is actually good for the secured creditors: it means they’re getting more than they otherwise would be able to salvage out of a liquidation. And when recoveries go up, raising cash becomes easier, not more difficult.

The Indiana pension funds who hired Lauria and brought the complaint are making very little sense:

“As I’ve said countless times, it wasn’t the investment that was made by our Hoosier pension funds that put Chrysler in bankruptcy,” says Indiana State Treasurer Richard Mourdock. “It’s been the egregious actions of the U.S. government.”

Actually, Chrysler went into bankruptcy because it ran out of money. The overwhelming majority of Chrysler’s secured creditors, knowing a good thing when they saw one, signed on to a plan which allowed Chrysler to come out of bankruptcy. The alternative would be to try to sell off Chrysler’s plants and other infrastructure — assets for which there’s not exactly a lot of bids out there.

Now, depressingly, Lauria has his eyes set on the GM bankruptcy — even though there are no issues surrounding senior creditors at all in that case: GM’s secured creditors are getting paid out in full. The fact is that the government has spent tens of billions of dollars bailing out both Chrysler and GM; bondholders of both companies are much better off as a result. They have nothing to complain about, and it’s ridiculous that anybody is willing to pay Lauria $900 an hour to try to throw a spanner in the bankruptcy works.

Proof that you don’t need elaborate CDS conspiracy theories to find lenders trying to drive borrowers into default:

Some of the largest lenders to the private equity groups that led the $23.8bn buy-out of Clear Channel Communications intend to turn down a proposed debt exchange, hoping to drive the radio and outdoor advertising company towards default.

The company, taken private in a leveraged deal that came to symbolise the excesses of the buy-out boom, has proposed a swap of some parent company debt for debt in Clear Channel Outdoor Holdings…

However, some of its largest senior creditors say they would rather wait, in the hope the company will violate its lending agreements, enabling them to force a default and to take control of its equity at a steep discount.

This might have been part of the game plan all along, for the junior lenders. In a highly-leveraged deal such as this one, the chances of default are quite high — and the junior lenders, being junior, are generally well aware of the downside risk. But at the same time they’re also well aware of possible upside: if the company violates its covenants and the junior lenders take control of the company, they can actually end up making more money than if Clear Channel simply made all of its debt payments in full and on time. As ever, the closer you are to equity in the capital structure, the more like equity your investments behave.

Fights within the confines and around the edges of bankruptcy can be extremely brutal and dangerous, even when there’s no CDS complication, and both risks and potential returns are very high in these situations. Expect much more of this kind of thing over the next five years or so, as leveraged loans mature with little if any chance of being rolled over easily.

A lot of fortunes will be made and lost within the private-equity and hedge-fund industries, but thankfully the systemic consequences are likely to be minimal. After all, in nearly all of these cases the underlying companies are still very profitable, assuming they can get their debt load down to a reasonable level. So we’re not going to see all that much in the way of damaging liquidations. And in fact if the companies do emerge from these fights with lower debt loads, that will help them borrow and invest more going forwards, which should help, rather than hurt, the economy.

David Reilly has come out with one of the purest forms yet of the “legal rights” meme:

Bondholders are told to give up legal rights, and cash, as part of a government-mandated tradeoff that favors a politically connected special-interest group.

The big threat is that this policy will extend to all bonds, including Treasury and municipal debt, not just corporate obligations…

The president, Einhorn said, had introduced a “quixotic idea” into credit markets: “that creditor recoveries in troubled situations can be determined by an arbitrary sense of shared sacrifice rather than legal agreements and long- established prior practice.” …

That theme was echoed at the Sohn conference by Paul Singer, head of Elliot Associates LP, one of the biggest and most successful hedge-fund managers.

Singer’s funds have used the courts to enforce their rights as creditors. He spoke of his concern the law will be circumvented.

Yet even here, in an 800-word column devoted to the subject, Reilly can’t actually name a single “legal right” which GM bondholders have been told they have to “give up” or which has been “circumvented”. Instead, he’s reduced to a vague sense of “that’s not fair”:

In the run-up to GM’s Monday bankruptcy filing, bondholders were told they would do far worse in a government-organized and -financed restructuring than would a health-care trust fund for GM’s unionized retirees. That was the case even though bondholders were owed $27 billion versus $20 billion for the trust, and even though bondholders’ claims were legally equivalent to those of the trust…

The deal certainly didn’t represent, as Obama said during a Monday press conference, an “equitable outcome” for bondholders.

Reilly neglects to mention, here, that the bondholders are going to get a huge chunk of the “old GM” — the assets which will remain in Chapter 11 after the “new GM” emerges from it. The UAW isn’t.

But more to the point, an unsecured creditor has no “legal right” to get exactly the same outcome as any other creditor with whom she is pari passu. The creditor does have the legal right to kvetch to a judge about fairness, that’s about it. And if the bondholders have a better idea of what’s fair, they’re more than welcome to provide tens of billions of dollars in debtor-in-possession financing in order to make that happen. But of course they’re not willing to put in so much as a nickel, which means that it’s not up to them, and the entity providing the financing — in this case, the US Treasury — gets to call the shots.

As for Paul Singer, I’m curiously untouched by his crocodile tears over bondholder rights. Yes, he regularly goes to court to enforce those rights — that’s how he makes high returns for his hedge fund. If there were nothing to complain about, he’d be out of a job. And, of course, he’s very politically active on the Republican side of the aisle: it’s unlikely he’ll ever have anything particularly nice to say about the Obama administration.

So let’s find a legal expert to come out and say that certain specific rights have been overridden. Or, if we can’t, let’s drop this meme altogether.

I’m fascinated that after roundly rejecting GM’s offer to swap their bonds for equity in the existing company, GM’s bondholders seem to have embraced with alacrity GM’s new offer to swap their bonds for equity in a new, post-bankruptcy company. It’s increasingly obvious, it if wasn’t clear all along, that the old exchange offer was in neither GM’s interest nor in that of the bondholders, and that bankruptcy is necessary to allow GM to shed certain obligations — especially obligations to its dealerships — which would otherwise hobble it for the foreseeable future.

The new plan essentially constitutes the nationalization of GM: the US government will own 72.5% of the common equity, plus another $2.5 billion in preferred stock. I can see why bondholders like it: the US will be extremely hesitant to let any state-owned company default, and it won’t sell off its stake until GM’s future viability is assured.

Everybody was worried that a GM bankruptcy would be vastly more complicated and fraught than the Chrysler bankruptcy, given that it has orders of magnitude as many creditors as the private Chrysler. But today’s news gives me some hope that both bankruptcies might go relatively smoothly, as planned and hoped. Although I still have no idea why GM’s shares are trading at over a buck apiece, valuing the existing common equity — which will be wiped out — at more than half a billion dollars.