November 21, 2008
The US government has begun discussions on the anticipated Federal bailout of the US automotive indusrty. This past week the CEOs of the Big 3 US auto manufacturers and the president of the United Auto Workers union faced questions at hearings from the US Senate and House of Representative on the dire state of the industry and why a bailout in the form of loans is justified. As part of the discussions the House of Representatives released a draft version of a $25 billion Auto Rescue Bill that would provide direct loans to automakers.
The draft legislation insists on the following specific measures to qualify for emergency loans:
Short-term Operating Plan – The automaker must submit a short-term operating plan that describes the intended use of the loans, including the commitment of resources to develop a long-term restructuring plan and repayment of the loan to taxpayers with interest.
Long-Term Restructuring Plan – By March 31, 2009, loan recipients must submit to Treasury an acceptable restructuring plan for long-term viability and international competitiveness, including meeting enhanced fuel efficiency standards and for advanced technology vehicle manufacturing, and restructuring of existing debt.
Executive Compensation and Corporate Governance – All executive compensation restrictions from TARP apply to loan recipients for the duration of the loan plus the following additional restrictions:
- No bonuses to employees making more than $200,000 (which Treasury will adjust for inflation).
- No golden parachutes under any circumstances.
- No compensation plan that could encourage manipulation of reported earnings to enhance compensation.
Warrants – Treasury must obtain warrants from each loan recipient (or economic equivalent in the case of a privately held firm) equal to 20 percent of the loan or such greater percentage as may be determined by Treasury in consultation with the Oversight Board.
Dividends – Recipients may not pay any dividends for duration of the loan.
Acceleration of Repayment for Failure to Comply – If a company receiving a loan fails to prepare an acceptable restructuring plan, the Treasury can demand accelerated repayment of the loan.
Terms of Loans:
- Term: 7 years (or longer as may be determined by the Oversight Board).
- Interest Rate: 5% for first 5 years and 9% thereafter.
- Super Seniority: All other obligations and liabilities of a recipient will be subordinate to the loan—putting the taxpayer in the first position for repayment.
The hearings were uneventful and about what one would expect from such a political exercise. My take-away was given the banking industry bailout Congress did not want another AIG fiasco where the company received an $80 billion bailout from the government and just recently came back for more money. My sense was Congress felt like it was burned by the lack of accountability and oversight of the US Treasury Department’s handling of the $700 billion bailout of the banks and did not want to make the same mistake with the auto industry. With that in mind, Congressional concern was focused on the long term viability of the auto companies prior to releasing any money. There is no doubt the tone of the hearings was skeptical on the part of Congress given its poor perception of the industry as the sellers of large gas guzzling pick-up trucks and SUVs and being out of touch with American car buyers when compared with the Japanese.
All three auto chiefs told congress they are willing to accept reasonable conditions from congress to receive the federal aid. However, suggestions by some in congress on limiting executive pay, more fuel-economy regulations and prohibiting the funds from being used on mergers as conditions for the aid was deflected as not being sound or contusive for a recover by the CEOs.
Of interest was some insight into the financial state of Chrysler LLC. In his testimony Chrysler’s CEO Robert Nardelli told congress the company has only $6.1 billion on hand and about $4 - $5 billion a month in operating costs (salaries, benefits and suppliers). Furthermore, Chrysler burned through $3.3 billion in cash in the third quarter. The last time the company provided any information as to its financial health was back in June when the company disclosed it had $11.7 billion in the bank. Nardelli told congress the company has cut $2.2 billion in fixed costs and 1.2 million units of capacity so that it is at the breakeven point. He also told congress that the company has looked into an expedited bankruptcy process where the terms were prearrange so that the company could emerge within months instead of year prior to seeking help from the government.
“We looked at pre-negotiated. We've looked at almost every alternative within Chrysler as a privately held company before we came here and ask for support.”
“We just cannot be confident that we will be able to successfully emerge from bankruptcy."
"We're doing everything humanly possible to survive this current period."
Chrysler’s burn rate of $3 billion in the 3rd Quarter is believable given GM and Ford consumed $6.9 billion and $7.7 billion in the same period.
The outcome of the hearings appears Congressional leaders were not convinced by the testimony and believe there was not enough support to pass any legislation at this time. The bailout talks are officially on hold until each company provides Congress with a business plan outlining how the companies would use the aid to create a viable entity. Congress understands the urgency of the bailout loans for the auto manufacturers and will schedule hearings the week of Dec. 2 on the automakers' plans and a vote on a bailout likely by the middle of the month.
Speak of the House of Representatives said:
"Until they show us the plan, We cannot show them the money."
In reaction to the Congressional decision, Ford and GM have both issued statements that they would submit plans as requested. UAW President Ron Gettelfinger, also issued a statement saying the auto union is open to concessions.
"We're at the table every day, and we would welcome all of the other stakeholders to the table to make some concessions."
One concern I have is the very recent development that Congressman Henry Waxman (CA) has unseated auto industry ally John Dingell (MI) as the Chairman of the House Energy and Commerce Committee in the next congress. This committee has direct oversight of the automotive industry and has the authority to propose new safety and fuel economy regulations. Dingell who has been the top ranked Democrat on the committee since 1981. Waxman has been known to blame the US auto industry for resisting higher fuel economy, environmental and safety standard and generally supports policy that is not in the automakers best interest. For example, Waxmam supports a bill that would allow the California Air Resource Board to regulate CO2 emissions and fuel economy for CA and 13 other states well beyond federal requirement. Late last year I discussed the implications of this issue at length (EPA Denies CARB Waiver Petition to Regulate CO2). This news makes for an urgent need that an auto aid package is approved before the first of the year when the new congress takes charge.
As the auto bailout talks in Washington are on hold, there is continued talk about the automakers needing to file for bankruptcy protection as the best option. The automakers continue to deny Chapter 11 is a viable option to restructure the companies. I agree with their assessment of the situation even though many industry pundits, analysts and US Congressman believe that is their best option.
Even former Republican presidential candidate and Massachusetts Gov. Mitt Romney has opined on the state of the automotive industry with much certainty. Romney’s father, George W. Romney was once the head of the now defunct American Motors during the early 1960’s before becoming the governor of Michigan. In a recent NY Times Op-Ed on the subject Romney stated:
Without that bailout, Detroit will need to drastically restructure itself. With it, the automakers will stay the course — the suicidal course of declining market shares, insurmountable labor and retiree burdens, technology atrophy, product inferiority and never-ending job losses. Detroit needs a turnaround, not a check.
First, their huge disadvantage in costs relative to foreign brands must be eliminated.
Second, management as is must go.
Investments must be made for the future.
In a managed bankruptcy, the federal government would propel newly competitive and viable automakers, rather than seal their fate with a bailout check.
First off, Romney as do many pundits including leaders in Washington ignore the significant cost restructuring programs these companies have undergone not since the financial crisis in September but since 2005 including, reduction in executive compensation, suspension of dividends to shareholders, elimination of 401k contributions to salary staff, a historical new labor agreement with the UAW in 2007, employee buy-out, plant closing, etc.
Secondly, a Chapter 11 bankruptcy is not an option for the manufacturers. On the surface Chapter 11 makes sense as it enables the debtor to restructure the company and its debt obligations under protection of the law while allowing for the company to continue operations. However, proponents of this option chose to ignore some valid concerns given the nature of the business and current economic climate.
The manufacturers will argue that sales will drop as customers lose faith in the company when is comes to honoring warrantee and service over the life of the vehicle and remove the company’s product from consideration. I agree with that position. To the public, bankruptcy means going out of business and the company’s doors will be closed. A vehicle either is the first or second largest household purchase and consumers need to feel reassure. If that perception of trust is not present or in question, vehicle sales for a manufacturer under bankruptcy could collapse. Although this argument can be construed as speculative my next point is not.
Of a more practical nature is proponents of a Chapter 11 filing assume or neglect to factor in Debtor-In-Possession Financing (DIP) that must be established for a company to restructuring when under bankruptcy protection. Debtor-In-Possession Financing is a financial arrangement such as a line of credit established by a company while under the Chapter 11 bankruptcy process that will allow the company to continue operation during the restructuring process. DIP financing is unique from other financing methods in that it usually has priority over existing debt, equity and other claims. The reason why this is not appropriate is that the vehicle manufacturer in today’s economic climate will not be able to raise the necessary capital from the banking sector to properly restructure. This is the reason why the companies have lobbied the US government for a $25 billion federal aid package. As a result, when the companies do run out of cash, their only realistic option is bankruptcy under Chapter 7 – Liquidation.
It is my assessment that because Chapter 11 bankruptcy protection is not an option and there is a very urgent need for Congress and the White House to agree upon a deal before the first of the year. It is in the industry’s best interest to cooperate with congress because of GM and Chrysler’s immediate need for cash and the potential complications Henry Waxman should bring as the Chairman of the House Energy and Commerce Committee.
For the most part, I agree with the the draft legislation proposed by the House, however, I will raise a few points that need to be considered as the bill goes forward. It is my opinion that the federal aid package should be conditional on the following:
- Pay cuts across the company including executives, white collar and executives.
- Reconsideration of the UAW healthcare VEBA negotiated in 2007.
- GM white collar retirees will not receive health care as of 2009.
- Current leadership is to remain in place as they are not the reason for the bailout.
- Government representative on the Board of Directors as oversight.
- Details progress report to Congress on quarterly basis.
- Consideration of reviving the GM-Chrysler merger.
- No aggressive fuel economy stipulations that go beyond industry wide requirements.
I believe the above is a reasonable compromise that will protect Congress, the tax payers and industry. A GM-Chrysler merger should not be dismissed. The US industry has excess capacity and GM absorbing Chrysler and liquidating or closing down big portions of its operations makes sense. Congressional oversight and accountability is also very important because a constructive dialogue between the government and industry has been lacking for decades and this could encourage a more harmonious relationship. It is also very important to inform Congress of the health of the industry so that they are aware of the challenges the industry faces in the near future. In the end it would guarantee failure if congress were to include language in the legislation that would tie the hand of the recipients of the federal aid and force them to become uncompetitive in the greater US market.
Given the situation, there does not need to added uncertainty by replacing leadership at the companies. The current management at GM and Ford has put in place and executed a bold restructuring effort in recent year. Continuity at this time would benefit both companies, however, a government presence on each company’s Board of Directors would provide good political cover for Congress as well an added layer of oversight.
Lastly I will note that the Healthcare VEBA established in the 2007 contact should be reconsidered if the funding is not deemed feasible and threatens the survival of the companies. My objection is rooted is the unfairness that GM’s white collar retirees will not receive company sponsored health care benefits starting in January 2009 and that the playing field needs to be leveled for all retirees. I also object to any aid being contingent on fuel economy or safety requirements that are targeted at the recipients beyond what is required by the larger industry. The conditions in the US must be equal and fair for all the manufacturers.
I will also note that GMAC, the financial service arm of GM co-owned with Cerberus has formally applied to become a bank holding company. Congress should also encourage the appropriate federal agency to review the application. The sooner a decision is rendered, the sooner a degree of uncertainty is removed from the equation. I still believe, Cerberus will exchange with GM, GMAC for Chrysler and expect this will be presented to Congress next month for its approval.
Most of the big and expensive restructuring at the GM and Ford has been completed. This should help reduce their burn rate. With that, I would have to expect the necessary restructuring needed now would be an industry consolidation to rationalize production. My assumption is, I am not anticipating a rebound in vehicle sales anytime soon and estimate vehicle sales will settle at around 10-13 million sales a year (down from 17 million a few years ago). GM and Ford’s current situation is not so much a matter of the companies not restructuring but related to the greater economic downturn. Government aid is expected by the end of the year for at least GM and Ford and it is hoped that it is conditioned on restructuring the industry to the new lower volume by encouraging or supporting drastic action at Chrysler. Even if the economic environment were normal, I believe Chrysler's future is very questionable. Finally, the sooner the aid arrives the sooner the companies can get back to developing new product which will help the surviving companies recover once the economy turns around.
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