All That Glitters / Three Haircuts for Your Money

How does Yossi Israeli suffer when the big companies get into trouble? Let us count the ways.

Haircuts have been all over the headlines these days, and you're the one paying for the coiffeur.

In market argot, a haircut is a partial default on bond debt. When you buy a bond, you're lending money to a company. You expect that money back with interest. A haircut is when the issuer admits he can't repay you in full and needs to reach a debt arrangement.

Put simply, these haircuts mean that us men and women who have been scrimping for our futures, are losing money on funds they entrusted to medium and long-term savings managers such as provident funds, insurance companies and pension funds.

But just like at the barber shop, the financial world offers several styles of haircuts: three, to be exact. For each snipping style in this trio, a different group is responsible.

1. Haircut by debt arrangement

This is most well-known type of haircut. The financial press is filled with examples. It's no secret that a growing list of companies can't pay their debts, forcing their owners to scramble for ways to restructure their debt. Yitzhak Tshuva’s Delek Real Estate, Ilan Ben-Dov’s Tao Tsuot, Yossi Maiman’s Ampal and Roni Elroy’s KMN Holdings are just a few of the companies that put you in this particular barber's chair.

At the end of the process, during which the owners sometimes, but not always, cough up some of their own cash, bondholders are told how much of their money they're getting back. Put otherwise, they learn how much of the debt the company isn't honoring.

Yitzhak Tshuva's Delek Real Estate for instance is giving its bondholders a haircut of 65% to 70%, meaning the bondholders will get back 30% to 35% of the bonds' adjusted value.

Note that not everyone gets the same haircut. Bondholders who bought bonds when first issued, usually institutional investors, will get the haircut exactly as specified in the debt arrangement. But for the bond traders and speculators who bought later, after the bond had crashed in price, the calculation will vary. Their outcome depends on the purchase price they paid. In some cases, they'll lose less money than the general public. Sometimes, if they paid rock-bottom for the bonds, they can make a fortune.

The money involved can be huge. In Delek Real Estate’s haircut alone, even though Tshuva pay nearly NIS 800 million of his own money, the bondholders are losing NIS 1.5 billion. And that's just one of many Tel Aviv-listed companies waving scissors at their investors.

Who's to blame? In business, if you borrow and can't repay, you bear the responsibility. But fixating on that won't help. In a capitalist, free-market economy, where there is a legal separation between a business and its owner's personal assets, the owner will generally keep as much as he can, especially if the one losing out is an amorphous " general public" that nobody's looking after. Certainly it can't be said that institutional investors bent over backwards to protect Israel's savers from the dread haircut.

So the fingers, then, should really be pointed at those who handed the public's money to the businessmen in the first place – the managers of the institutional investors.

They should have been more conservative and cautious. They should have asked for more collateral, and they should paid less for funding the entrepreneurs' dreams.
They should have taken to heart Warren Buffett’s two basic rules of investment – 1) never lose money; and 2) never forget Rule No. 1.

Instead, many of these guys played fast and loose with money that was the public's, not theirs. They preferred the carrots received from handing it over to the tycoons over the sticks they would have received had they refused.

2. A haircut via the stock market

Even though haircuts that result from debt arrangements are huge, it seems that haircuts given to the public’s money via the stock market are larger still.

This is how it works. Once the company that issued bonds to the public is in trouble, institutional investors don’t wait for a debt arrangement, or for the court to liquidate the company. They dump the bonds on the market, usually at a fraction of the price they paid.

This has happened with IDB Holding Corp. The company isn't negotiating a debt arrangement with investors and says none is needed, yet most of the public has already taken a haircut because the institutional investors dumped IDB Holding’s bonds on the stock market at a big loss.

Why do institutional investors do this? Sometimes it's the right call, for example, if the sale took place before a crash, while the public’s loss was still small. In other cases, the institutionals sold off the bonds to avoid having to negotiate with strong players, such as Nochi Dankner and Yitzhak Tshuva; the negotiations would be awkward and might be bad for their careers.

In still other cases, they simply wanted to dodge their responsibility to the public. The ones who sold the merchandise, even at a substantial loss, do not get into the newspapers or the media. But those who kept it would have to explain the loss and the way they managed it during the debt arrangement proceedings.

That can be proven. Last week, a new player entered the market. It exposed the Israeli institutional investors' weakness, lack of independence and unprofessionalism.

While IDB Development’s bonds (which belonged to the public) were trading at a loss of 50 percent and more, the U.S.-based York Capital Management came along and snapped them up. Some days ago, York, which has acquired about one-fifth of IDB Development’s public debt so far, submitted a strategic plan for curing and managing the IDB group, including the alternative of a hostile takeover and taking ownership away from Nochi Dankner.

In response, IDB Development’s bonds soared by as much as 40 percent within two trading days. Why did a foreign financier have to do what no Israeli institution dared even to plan?

Who is responsible? In a haircut given via the stock market, there is no reason to blame the company owners. Dumping bad bonds on the market for the sake of convenience, fear of a powerful tycoon (or greed for a cushy future job with said powerful tycoon) – these are 100% the responsibility of the institutional investors.

3. Haircut by bank

It is not only the public who loses when a company gets into trouble and can't repay debt. In many cases the banks, which lent vast sums to the tycoons, have to write off debt too.

Whether the haircut is full or partial, it is noted in the bank’s ledger and subtracted from its equity – the number that determines the bank’s value on the stock market.

Supposedly, the haircut has nothing to do with the public. This is the bank’s money, and writing off the debt has no direct effect on the provident funds or the public pension fund. Right?

Not right. For all practical purposes, all the banks in Israel, and certainly the large banks, are owned by the public, even if other people own a small controlling share.

The public owns about 94 percent of Bank Leumi’s shares (of which Shlomo Eliahu owns 10 percent). The state, which is, once more, “the public,” owns the rest. The public owns eighty percent of Bank Hapoalim’s shares, while Shari Arison owns only 20 percent. The public owns seventy-five percent of Bank Discount’s shares, while the Bronfman Fisher group owns the rest.

Since any haircut of this kind harms the bank’s equity, it also harms the value of its shares – which, in turn, harms the entire public.

Everyone is affected, including those who do not directly own any bank shares.

There is almost no provident fund or company insurance plan that does not own a substantial amount of stock in Bank Hapoalim or Bank Leumi. And so, when the CEO of Bank Leumi, Rakefet Russak-Aminoach, writes off Nochi Dankner’s debt or that of Yitzhak Tshuva from a project in Las Vegas, the public gets a haircut once again, this time via the bank loan.

Who is responsible? Like the haircut via the stock market, the responsibility for the loss falls upon the ones who gave the money: the bank managers, who for many years had close and friendly relationships with the tycoons who took the credit they extended. The public paid the bill, both in the decreased value of the bank shares and in the fees and high interest gaps that the banks charge households and small businesses in order to compensate for their losses and their low profitability in the “big business” sector.
 

Reuters