Debt Junkies Forced to Go Cold Turkey

Companies that depend on cheap credit to keep going are like hard-core heroin addicts, living each day from fix to fix. Once the drug -- or the borrowed money -- runs out, many either go through painful withdrawal or they end up in the gutter, lifeless. In "Junk Sales Mirror '91 Recession and Bankruptcies," Reuters details evidence that suggests the debt junkies are suddenly being forced to go cold turkey.

Bankruptcy lawyers: Sharpen your pencils. This could be a frenzied year in U.S. bankruptcy courts, according to signals flashing from the global junk bond market.

High-yield debt sales have sputtered so far in 2008 and are off to their weakest start in 17 years thanks to an anemic U.S. economy, a worldwide credit crunch and a pronounced absence of investor appetite for risky assets.

That's a striking change from the go-go days of the leveraged buy-out boom, when the world's less-creditworthy corporations found little difficulty raising funds through bond offerings. Now those companies are shut off from this vital source of fresh capital, a slump that typically precedes a surge in corporate bankruptcies.

"2008 will be a busy year for insolvency professionals," said Sam Gerdano, executive director of the American Bankruptcy Institute in Alexandria, Virginia. "Whether it's a record year remains to be seen."

Globally, less than $2 billion in junk bonds have been sold so far this year, all in North America. That marks the slowest start since the 1991 recession, when no junk bonds were sold in the first two months, according to Thomson Financial data.

"Historically, high yield sales and defaults rates have always been a precursor to corporate bankruptcies," Gerdano said. "We see atmospheric conditions that are troubling."

Indeed, Chapter 11 filings are mounting. In just the past week, Wellman Inc, a specialty plastics maker, Lillian Vernon Corp., a low-cost gift vendor, and Sharper Image Inc, the retailer of high-tech gadgets, have sought protection from creditors.

So far this year, at least 16 public companies have filed for bankruptcy, representing nearly $9 billion in assets. As measured by assets, that's the fastest start since 2002, when a wave of 220 firms filed for bankruptcy in the first two months of that year in the wake of the dot.com market crash, affecting $65 billion in assets.

Through September 30, 2007, the latest period for which data is available, quarterly bankruptcy filings have climbed for six straight quarters, according to the Administrative Office of U.S. Courts.

Standard & Poor's forecasts default rates on junk bonds may rise to 4.6 percent in 12 months, from about 1 percent at the start of the year.

"Credit metrics for the high-yield universe should continue to deteriorate through 2008 as corporate profits slow," said S&P Managing Director Diane Vazza.

The closing off of credit lines is similar to the credit crunch after 2001 and 2002, but the impact from the U.S. subprime mortgage crisis could be more widespread and affect more industries, analysts say.

S&P said defaults are most likely for "weakest link" issuers rated in the lower tier of junk. Those issuers, rated "B-minus" or worse, have seen a rising risk of default since mid-2007, according to S&P.

END OF LEVITTOWNS

Default rates have not leapt yet, though all the main ratings companies forecast acceleration this year. While not all bond defaults lead directly to a Chapter 11 filing, it is typically a big step toward that process.

Also, there is a bounty of high-yield debt in the secondary market after the leveraged buyout boom that stretched from 2003 through the middle of last year. History shows that periods of hefty junk bond issuance are followed within a year or so by a spike in bankruptcies.

For instance, after a surge in high-yield bond sales in 1997 and 1998, sales fell in 1999 and plummeted further in 2000, according to Thomson. Bankruptcies filings then soared to 179 in 2000 and rose to a record 263 in 2001, according to bankruptcy court records.

Casualties began emerging late last year, with notable collapses including Levitt and Sons, the homebuilder that pioneered mass-produced housing in U.S. suburban "Levittowns" after World War II.

January featured filings from restaurant company Buffets Holdings Inc. and Florida-based homebuilder TOUSA Inc.

Analysts expect these corporations to have plenty of company in the near future.

"There are a lot of defaults coming this year," said Kerry Mastroianni, a bankruptcy analyst at bankruptcydata.com. "And when high-yield bond issuance goes down, filings typically go up. We anticipate more filings."

Comments

[Rick]

Interesting insight just ordered the book can't wait to read.

[Retired U.K. fund manager.]

The oft repeated assertion, made by the permabulls, that balance sheets are strong is about to be tested.
There are still parts of Corporate America with immense financial strength but many companies have been seriously weakened as a results of the decades of irresponsibilty.
The obsession with immediate earnings per share growth, "efficient balance sheets", debt financed takeovers, share buybacks (often financed by taking on debt) and the like have left many companies over reliant on debt.
The price is about to be paid and many innocents will suffer.