Financial Regulatory Forum

ANALYSIS-Extended U.S. bankruptcies killed by cheap debt

By Reuters Staff
October 2, 2009

Cory Lipoff, the Executive Vice President and Principal of Hilco Merchant Resources, LLC speaks at the 2009 Reuters Restructuring Summit, September 30, 2009. REUTERS/Brendan McDermid (UNITED STATES BUSINESS) By Tom Hals
NEW YORK, Oct 2 (Reuters) – Years of easy credit followed by an economic downturn have led to a predictable wave of bankruptcies, but with a twist: layers of debt have essentially killed the expensive, drawn-out bankruptcies of the past.

Tumbling asset prices and the widespread use of second-lien debt, which puts another layer of claims on a company’s assets, has straitjacketed bankrupt companies as never before, experts told the Reuters Restructuring Summit in New York this week.

“Bankruptcies are very hard nowadays,” said Cory Lipoff, executive vice president of Hilco Merchant Resources.

Lipoff said retailers have offered every asset as collateral for loans, and often arrive in bankruptcy with liens even on their inventory, a big change from Chapter 11 cases in years past.

The result? Bankrupt companies such as Eddie Bauer have opted for a quick sale, or have been forced to liquidate to pay secured lenders.

“Every single case last year, and there were some really big cases, was a bank foreclosure essentially. Circuit City was essentially a bank foreclosure,” said Lipoff.

The lack of available assets to secure bankruptcy finance has also forced companies to reach agreement with creditors and enter Chapter 11 with a prenegotiated plan. Few companies are collapsing into bankruptcy as Kmart did in 2002, or lingering for years as United Air Lines Inc did.

“I think what you will see is a lot of prepackaged, prearranged, those types of things. People utilizing that to wash the company clean,” said Michael Kramer, the head of restructuring for Perella Weinberg Partners.

Many of the panelists agreed that the severely leveraged companies had few options, prompting the wave of quick sales in bankruptcy, a strategy used by Chrysler.

“If you can do it in a way so that you are filing and emerging within 90 days or 60 days, whatever the fastest is you can do it, that’s ideal. It saves on costs, both direct and indirect costs, for the company,” said Rob McMahon, managing director of GE Capital Restructuring Finance.

A booming high-yield debt market has also given troubled companies an alternative to restructuring or bankruptcy, allowing them to use newly raised money to pay down maturing debt.

John Lonski, the chief economist with credit rating agency Moody’s said that in 79 percent of recent high-yield bond issues that he had examined, at least some of the proceeds were used to pay down debt.

But issuing new debt is not fixing underlying problems.

“The high-yield financings of the last six to eight weeks haven’t fixed the credits,” said Barry Ridings, the vice chairman of U.S. investment banking at Lazard. “If anything, they have exacerbated the problem because generally the interest rate on the new debt is a lot higher than interest rate on the old debt. So it will cost them more.”

Out-of-court restructurings are more likely when a company has a stable cash flow and is burdened with unsecured debt, said the specialists. That allows them some room to swap it for equity or secured bonds.

Lipoff said the recent decline in bankruptcy filings may not be a sign of recovery, but a reflection of the “covenant-lite” loans written during the height of the credit boom.

“There are a lot of companies that may well not have a default until they run out of cash,” said Lipoff. As a result, he said that “since June, I think, there have not been a lot in the way of retail bankruptcies.”

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