Tuesday, May 19, 2009

Collateral, Collateral Everywhere

Posted on Credit Slips by Stephen Lubben:

IDSA has been trumpeting the increased use of collateral in derivative transactions, which is said to reduce the systemic risk associated with derivatives. An article in today’s Financial Times notes that non-financial users of derivatives are concerned that the Administration’s regulatory plan will increase costs by requiring all parties to at least partially collateralize their positions.

The effects of all this collateral on the bankruptcy system are little discussed. But given the flagrantly broad safe harbor provisions currently in the Bankruptcy Code, more collateralized derivatives means more of the debtor’s assets will leak out of the bankruptcy system.

Traditionally the U.S. has had higher recovery rates on unsecured debt than other developed economies, a phenomenon I’ve often attributed to the well-developed reorganization system. But the increased use of security interests, not only in the derivative context but also with regard to second lien financing, means that this probably will be changing.

Indeed, the unsecured creditors of both GM and Chrysler may receive very little recovery if they are not lucky enough to be critical parts of the new forms of these companies. Indeed, I'd expect that the Chrysler unsecured creditors who are "left behind" will receive nothing, given that the senior secured lenders will remain only partially paid after application of the sale proceeds.

All this as the Financial Times also reports that individual investors are rushing into high yield debt mutual funds.

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