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KIM: Trump's bankruptcies hold important investor lessons

December 5, 2015

KimWhen asked about his history of bankruptcies, Donald Trump’s response has been 1) none of the bankruptcies was personal and 2) the bankruptcy laws are simply a financial tool that every major financier has used to his/her own advantage. In other words, declaring bankruptcy can be “just good business.”

When a company files for protection from its creditors (including banks, bondholders, landlords and suppliers), it’s generally under Chapter 11 of the U.S. Bankruptcy Code. It enables the debtor company to stay in business while it attempts to reorganize/restructure its business and finances.

In a typical Chapter 11 bankruptcy reorganization, all parties suffer (except the lawyers). Creditors take a significant “haircut” on the amount owed and the owners’ investment is effectively wiped out.

Back in 1976, New Jersey’s voters heeded the siren call that casino gambling would bring an unending bounty of cash. With Las Vegas 2,500 miles away, Atlantic City would have the Northeast to itself. Unfortunately for those who invested in Atlantic City, neighboring states also heard the call.

A corporate bond is a contract between the issuer and buyer specifying when periodic interest payments will be made and the principal repaid (the “maturity”). Standard & Poor’s and Moody’s rate bonds along a spectrum from most to least creditworthy. Bonds are classified as “investment grade” (BBB- or better by S&P, Baa3 or better by Moody’s) or “speculative.”

Unlike with a stock, a bondholder has no upside beyond receiving the periodic interest payments and return of principal. Thus, bondholders need to be adequately compensated for the risk that the issuer becomes unable to make the contractual payments. The higher the risk, the higher the interest rate or yield required.

With U.S. corporate bonds, this risk premium is expressed as the yield difference or “spread” versus the comparable maturity, “riskless” U.S. Treasury bond.

The Trump Taj Mahal opened in April 1990 to great fanfare (including an appearance by Michael Jackson), but missed its very first interest payment that October. The Taj filed for bankruptcy protection in 1991. Trump had personally guaranteed $900 million of the Taj’s debt.

Trump reportedly avoided personal bankruptcy by convincing his lenders their best option for recovery was to work with him to restructure his debt. Still, he forfeited his Trump Shuttle airline and Trump Princess yacht and agreed to a personal spending limit.

Trump’s other bankruptcies were: the Plaza Hotel (New York City, 1982); Trump Hotels and Casino Resorts (Trump Taj Mahal, Trump Plaza and Trump Marina in Atlantic City; Trump 29 in California; and Trump Casino & Hotel in Gary, Indiana, 2004); and Trump Entertainment Resorts (Trump Taj Mahal and Trump Plaza, 2009).

John Pierpont “J.P.” Morgan was the world’s most powerful financier a century ago. During congressional testimony, Morgan was asked if commercial credit was based primarily on money or property. Morgan’s famous reply was, “No sir, the first thing is character. Before money or property or anything else. Money cannot buy it … because a man I do not trust could not get money from me for all the bonds in Christendom.”

This is sage and timeless advice for investors.•

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Kim is the chief operating officer and chief compliance officer for Kirr Marbach & Co. LLC, an investment adviser based in Columbus, Indiana. He can be reached at (812) 376-9444 or mickey@kirrmar.com.

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