Restructuring Redux?

Thanks to the availability of cash, the options for bankrupt companies — and their advisers — abound.

Before any battle, however, there has to be an opening salvo. But respondents to the ABI survey, which included attorneys, distressed-debt investors, bankers, and financial advisers, disagreed on the trigger, with 48 percent citing interest rates and the remainder pointing to home prices, commodity prices, global competition, and a bear equity market as factors.

To some observers, the low rate of bankruptcy filings could itself be the catalyst. Business bankruptcies were down last year, owing to a strong economy, low interest rates, and excess liquidity via hedge funds, private equity, and other sources. According to statistics compiled by New Generation Research, bankruptcy filings fell from a high of 263 in 2001 to 74 last year, the lowest since 70 bankruptcies in 1994.

“The default rates can’t go any lower, so logically they have to go up,” says Peter J. Solomon’s Maxwell. “It’s a cyclical thing. You can look at default statistics or sheer volumes and yield spreads and conclude we will have a ramp-up in defaults. The only questions are how much of a ramp-up and whether it’s this year or next.”

Penn, on the other hand, predicts a restructuring wave based on “unusual financings.” He explains, “The number of junior liens out there tells me that companies are starting to get stretched. Almost every bankruptcy seems to show up with a junior lien. After a boom time, people get the mentality that it’s impossible to fail. They either get into a market they shouldn’t get into or expand a product line that’s unwise, and take on too much leverage.” The second lien market, in fact, skyrocketed to $23 billion in loans in 2006, up from $16 billion in 2005.

Of course, the largest purveyors of those second liens — hedge funds — are also standing ready to bail out companies that get into trouble. Take the case of hedge fund Highland Capital, which owns 8.9 percent of troubled auto supplier Delphi in different ways, including stock, bonds, and bank debt. Highland recently presented Delphi’s board with a $4.7 billion rights offering to refinance the company, which filed for bankruptcy protection in 2005. Under the plan, existing stockholders with more than 0.5 percent of the common shares would be given the right to purchase Delphi’s unsubscribed shares. Highland is not alone in its bid; its offer represents an alternative to the $3.4 billion deal presented by another hedge-fund group that includes Cerberus Capital Management and Harbinger Capital Partners Master Fund.

In the end, though, it could come down to one event tipping the scales to a restructuring bonanza. “I think the market will be hit by an electrifying event that is impossible to anticipate today, but in hindsight will be very clear,” says Maxwell. “In 1989, the event was the collapse of a leveraged buyout of United Airlines. That’s when the markets realized the emperor had no clothes.”

Watch Your Elbow

If companies do get into trouble this year, the courtrooms will be crammed. “There are all these layers of financing in different tranches and different types of collateral changing character, which is sure to drive an intramural fight among creditors,” says Penn. Among these different players are senior secured creditors, junior secured creditors (a lot of them junk bonds), the bondholders (also junk bonds, depending on whether the junior debt is secured or unsecured), and the trade creditors. “On top of this you have the claim-trading business and loans on the bank side that are basically syndicated. You end up with syndicated lenders that can change regularly, sometimes from one morning to the next.”

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