Not everyone views the prospect of an imminent about-face in the U.S. economy as bad news. For some, a major downturn is a significant money-making opportunity. According to recent reports, some of those who thrive in hard times are starting to gear up their operations.
In “Lawyers Ready for a Boom in Bankruptcy,” the Chicago Tribune reports that experts in the field believe the “business cycle will soon yield a surge in defaults.”
Business bankruptcy filings are down by 45 percent and corporate debt default rates remain near all-time lows. Yet bankruptcy pros are buzzing with anticipation.
While they don't have crystal balls, call them cynical and firm believers in business cycles. Lawyers, consultants and financial advisers who work with troubled companies are getting ready for the next surge in business, which some predict may come as soon as the end of this year.
"My experience over the last 20 years is that what goes up, must come down," said Jeff Marwil, a Chicago attorney who last month left Jenner & Block to join Winston & Strawn's larger bankruptcy practice. "Change is inevitable."
The credit markets that Marwil and his peers closely watch are enjoying one of the biggest expansions in recent history. Companies are borrowing cheaply, as banks and investors such as hedge funds are eager to lend. That has resulted in a flurry of debt-driven corporate mergers, spinoffs and buyouts.
It also means that struggling companies are more able to refinance their debt and delay fixing operational problems. One sign that the financial system is flush with cash: Business bankruptcy filings through the first nine months of 2006 totaled 14,228, compared with 26,275 in the same period the year before.
But some analysts are now warning that the good times could soon come to an end, meaning higher borrowing rates and more defaults--or what bankruptcy professionals like to call "inventory."
To prepare, some big law firms have bolstered their bankruptcy practices by cherry-picking prominent attorneys from other firms. Marwil is one of four attorneys Winston & Strawn recruited. Kirkland & Ellis lured an attorney from rival Weil, Gotshal & Manges in New York. Top-drawer New York firm Paul, Hastings Janofsky & Walker opened its Chicago office with two bankruptcy attorneys from Jones Day.
An uptick in hiring is also happening outside the legal profession. A 2006 poll of more than 200 financial-advisory and consulting firms by the Chicago-based Turnaround Management Association found that 37 percent had added employees last year, compared with 32 percent in 2005.
In anticipation of the next wave of corporate restructurings, the association held its first-ever "Distressed Investing" conference last month in Las Vegas. The meeting, which brought together turnaround experts with financial dealmakers who buy securities in troubled companies, had everyone asking the same question that some outside the industry might consider grim: When is the bubble going to burst?
"The conference was a huge success," said Colin Cross, chairman of the Turnaround Management Association.
Bankruptcy and restructuring work has slowed from its last peak between 2000 and 2004, when practitioners were working at a fever pitch. The period featured bankruptcy reorganizations by United Airlines and two other major carriers, as well as the bankruptcies of scandal-plagued companies such as Enron Corp. and WorldCom Inc.
"Bankruptcy lawyers were in as high demand as they had been in the last 20 years," said Michael Solow, a Chicago attorney at Kaye Scholer.
The need for restructuring won't necessarily mean an increase in bankruptcy filings in coming years, experts said. New bankruptcy laws and the high cost of going to court will dissuade some companies, especially privately held ones, from making public filings, said Richard Chesley, who left Jones Day for Paul Hastings in November.
"I think people are positioning themselves for a different market," Chesley said. "I think we're going to see more out-of-court settlements, especially among portfolio companies of the private-equity firms."
Others are also licking their chops in anticipation, as a report in the International Herald Tribune seems to suggest.
The founders of Cerberus Capital Management, one of the most renowned firms in the field of distressed debt, reinforced the negative stereotype image of the industry when in 1992 they named their company after a three-headed watchdog of Greek mythology that guards the entrance to the underworld.
But distressed debt specialists are feeling misunderstood at a time when they are preparing for business to pick up.
The latest uptick may not be around the corner: 2006 saw the lowest default rate for companies globally in almost a decade, both for those that are troubled, known as speculative grade, and those that are in good health, known as investment grade, according to a report from the rating agency Standard & Poor's.
The market will get going when the current healthy state of the world economy and the ample liquidity available for companies to borrow comes to an end. Economists are split both as to the timing of these events — some forecast the end of 2007, others 2008 or 2009 — and the reasons, ranging from interest rate rises to a terrorist attack. But the majority agree that the current economic boom cannot continue.
For most companies and bankers, a downturn is certainly not a reason to celebrate. That is part of the reason why the distressed debt industry has been stigmatized and those in it are sometimes referred to as vultures.
"We are not the ones to create the problem but to create the solution," says an industry source who, like several others, spoke on condition of anonymity because of the sensitive nature of the business.
He and other experts stress that distressed debt specialists come into a troubled company, having bought up a chunk of the company's debt that is mostly trading at a very low price, help it come up with a workable business plan and restructure its debt. Other creditors, like commercial banks, they argue, often just want to write off the debt and leave the company to sort out its problems or go into liquidation.
Profit makes it worth braving the opprobrium. Distressed debt investors on average more than double their initial money on investments that are on average three and a half years, they say.
Firms like MatlinPatterson, for instance, a boutique based in New York and specializing in distressed debt, became involved in the restructuring of the telecommunications giant WorldCom, which went bankrupt in 2002, in one of America's largest corporate bankruptcies. MatlinPatterson became WorldCom's largest creditor, helping it emerge from bankruptcy in 2004 and converting the debt it held into shares.
There is already enough distressed debt around for industry experts to keep reasonably busy: around £74.2 billion, or $145 billion, globally, according to Debtwire, a financial data company.
Distressed debt experts, however, see this amount as rather limited and look back with nostalgia to the big bankruptcies like that of the energy giant Enron and WorldCom; between 2001 and 2003 the distressed debt market was worth around $350 billion, according to industry sources.
The experts are anticipating future demand by beefing up their teams now.
"There has been a rise in distressed recruiting in the past year, both banks and hedge funds," says Dee Symons, a headhunter for Russell Reynolds Associates in London, "mainly in anticipation of the next change in the credit cycle. As yet there have been few defaults."
A Wall Street Journal article noting the scramble to pass the “Mortgage Hot Potato” even hints at growth opportunities in the imploding subprime finance sector.
In recent months, as home-price appreciation fell and borrowers faced rising interest rates, more people defaulted on their mortgages. That prompted Merrill Lynch and others to exercise their contractual right to demand the sellers buy back the loans. Under mortgage contracts, mortgage originators must often repurchase loans that default very early in their term or that come with underwriting mistakes, such as flawed property appraisals.
"Following early payment defaults, we exercised our contractual rights to return loans to ResMae and protect our financial interests," a Merrill spokesman said. HSBC declined to comment. J.P. Morgan declined to comment.
Yesterday Accredited Home Lenders Holding Co., a subprime mortgage lender based in San Diego, reported a loss of $37.8 million for the fourth quarter, partly due to heavy repurchases of dud loans from large loan buyers, compared with a year-earlier net income of $43.3 million.
Accredited uses credit lines from eight financial institutions to fund its mortgage lending. Those lines of credit contain covenants that could allow the lenders to demand prepayment of the outstanding balance if Accredited has two consecutive quarters of losses, the company said.
Accredited already has received waivers in some cases on those covenants and will need to seek more waivers from the lenders if the company remains in the red during the current quarter, it said.
Investment-banking firms and investment firms that bought mortgage-backed securities are hiring firms to scrutinize subprime portfolios for loans that violate contracts.
Clayton Holdings Inc. is working with a half-dozen investment-banking firms to identify loans that should be repurchased. Clayton has also been hired by two hedge funds to review mortgage bonds they own for potential repurchases.
"Nobody was doing this in earnest before late last year," says Kevin Kanouff, president of Clayton Fixed Income Services, adding that he expects the volume of putbacks "to trail off in the third or fourth quarter. The carnage that you are seeing...is not over."
I guess you could say there is always a bull market somewhere.
Comments