Jeremy’s Jenga primarily illustrates how a company may collapse from creditors pulling lines, and the concept of timing subordination.
If you are not familiar with the nail-biting game of Jenga, you may find it difficult to understand the illustration. Essentially how it works is that rows of 3 blocks are stacked up on top of one another to form a Jenga tower. Players then take turns to draw blocks from the tower one at a time. The aim is to not make the tower crumble. You lose if the tower crumbles on your turn. Refer to this video to get a better idea of how a Jenga game goes!
A company is like a Jenga tower, supported by borrowings from banks. The Jenga blocks represent liquidity of the company. Some companies have revolving facilities which, although short-term in nature, are perpetually refinanced by banks. The borrower may not be generating adequate cash flows, but the Jenga tower remains in equilibrium as it is supported by bank borrowings that the banks perpetually refinance when they mature.
Banks calling for the company to repay their facilities is similar to drawing Jenga blocks out of a Jenga tower. Companies that have adequate cash flows have many other blocks in the Jenga tower to support the structure. On the other hand, companies that are not generating adequate cash flows but instead overly reliant on revolving short-term debt, would find their Jenga tower jeopardized as the blocks become more and more scant.
Timing Subordination
Consider Company X that has 3 different creditors Bank A, Bank B and Bank C, with similar level of short-term revolving debt from each creditor which rank pari passu. Suppose Bank A has elite bankers trained using Creditbytes. These bankers from Bank A detect some early warning signals and decides to exit their exposure to Company X (i.e. draw a Jenga block). Company X has sufficient cash to repay what it owes Bank A, or may even draw on the facilities of Bank B and Bank C to repay Bank A. Bank A would then be able to recover the amount quietly and exit its exposure to Company X. Bank A exits scot-free while Bank B and Bank C are “timing subordinated”. They are subordinated in terms of repayment as Bank A got repaid first.
Often, Bank B and Bank C may be unaware that they are supporting a thinning Jenga tower, may not detect the warning signals and continue financing Company X for years before the problems become very apparent. Astute bankers would be able to assess early warning signals and avoid being timing subordinated.