Quelle Surprise! Corporate Bankruptcies Rising

Ah, what cheery news this morning. Oil at a new high, producer price increases running twice as high as expectations, real estate repossessions running double the rate of last year. Yet the Dow is up a tad on the report that New York manufacturing increased. Pray tell what is New York manufacturing, besides the garment business, artisanal cheese, Long Island wine, and tree farms? The last three items probably aren’t included in the factory index; nevertheless, a clearer image might staunch unwarranted enthusiasm.

Similarly, despite assurances that US companies are holding boatloads of cash, what is true in aggregate is not necessarily true on an individual basis. With roughly half the corporate bonds rated at the junk level, it doesn’t take much to push them into distress. This Bloomberg article also suggests that many companies facing bankruptcy aren’t merely otherwise solid operations struggling with too much leverage, but include businesses that are weak as well as highly geared:

U.S. corporate bankruptcies are accelerating as the economic slowdown compounds the end of easy credit…..Increased levels of distressed corporate debt signal that failures will accelerate, says Lynn LoPucki, a professor at the University of California, Los Angeles law school who studies bankruptcies.

The amount of distressed corporate bonds jumped to $206 billion April 11 from $4.4 billion in March 2007, according to a Merrill Lynch & Co. index of bonds yielding at least 10 percentage points more than Treasuries. The share of leveraged loans considered distressed was 16 percent at the end of March, the highest since 1997, says Standard & Poor’s, based on loans trading below 80 percent of their face value.

“Money was so easy, companies that should have failed were kept alive,” said Rick Cieri, a bankruptcy lawyer at Kirkland & Ellis in New York. He said bankruptcies will include businesses “with severe operational problems” and too much debt. “Companies may well be sicker when they enter Chapter 11.”…..

“Subprime was just a paradigm for the credit markets overall,” Maxwell said. “Now in the corporate market, the shoe is just beginning to fall, and we’re poised for a major correction that has been coming for at least a decade.”

Bankruptcy filings have just begun to increase. According to court records compiled by Jupiter eSources LLC, Chapter 11 business bankruptcies, including small, nonpublic companies, increased 16 percent in the first quarter of 2008. Under Chapter 11 of U.S. bankruptcy law, a company seeks court protection from creditor lawsuits while working out a reorganization.

“I think this is the beginning,” said Brett Barragate, a bankruptcy lawyer at Jones Day in New York. “You have rising defaults into a market where it’s virtually impossible to get refinanced.”….

Martin Fridson, chief executive officer of FridsonVision LLC in New York, a high-yield research firm, predicted that a recession as deep as the eight-month contraction that started in 1990 could push defaults to 16 percent.

The highest default rate for speculative bonds and loans since 1983 was 9.98 percent in 2001, during the last U.S. recession. The average annual default rate over the same period was 4.48 percent, Moody’s says.

Default rates may not rise along with a company’s financial distress this time as they have in the past because some companies got so-called “covenant lite” loans, without restrictions that can trigger defaults, said Kenneth Emery, Moody’s director of corporate default research, in an interview. The covenants are usually financial ratios that measure ability to service debts, such as a quarterly limit on total debt related to cash flow.

“Even if a company’s operating performance is sub-par, the bank issuers can’t force them into bankruptcy because there are no covenants,” Emery said. As a result, if a company does eventually file for bankruptcy, it will have even more debt, and less value….

The new wave of filings may be affected by debt from the era of easy credit. Some lenders have second and even third liens on a company’s assets. That puts them behind the creditor first in line to recover.

The tightening of loan standards means some companies may have difficulty obtaining so-called “debtor-in-possession loans” that fund operations as a company restructures. Others have had trouble getting financing needed to exit bankruptcy…

“It is apparent now that some companies may be postponing Chapter 11 filings because it’s not even clear they can fund themselves in bankruptcy,” Kirkland & Ellis’s Cieri said.