Puzzling drop in corporate bankruptcies

/ Source: The Associated Press

The Federal Reserve has been hiking interest rates at the fastest clip in a generation. Oil prices have soared above $70 a barrel. Such developments usually portend good times for the country's corporate restructuring specialists.

But not this time. Corporate bankruptcy filings dropped this year to their lowest level in at least six years. By some measures, Wall Street analysts say, financial distress among corporations has actually eased over the last year. The result has been a general scarcity of corporate restructuring opportunities. "It's across the board _ it's affected lawyers and advisers and turnaround specialists," said Deirdre Martini, a former U.S. Trustee in New York who this week joined finance giant CIT Group as a senior restructuring adviser.

The extent of the scarcity has come as a surprise to many turnaround professionals. In the first quarter of 2006, corporate Chapter 11 bankruptcy filings dropped to 1,291 _ a 15 percent decline from the same period of 2005, according to the Administrative Office of the U.S. Courts.

"I don't think I've seen it at this level ever before," said John Penn, a former president of the American Bankruptcy Institute in Arlington, Va.

Moreover, the frequency of "mega-cases" — such as those of Delphi Corp., Delta Air Lines and Northwest Airlines Corp. — has dropped sharply. The U.S. Bankruptcy Court in Manhattan, which tends to get most of those cases, received about a half-dozen such cases last year alone. This year, it has received one — that of Dana Corp. — and none since March.

Many turnaround professionals remain optimistic that the scarcity will end soon. The Turnaround Management Association said last month that 90 percent of the professionals it surveyed predicted a "rude awakening" for distressed companies by the end of 2007. Most of them said a "a blowup could occur as early as mid-2007," the association said.

Many analysts, however, say that forecast isn't supported by the evidence. "I'm not sure what is causing people to say the cycle will come to an abrupt end unless it is a self-fulfilling prophecy," said Peter Spratt, a senior managing director with PricewaterhouseCoopers in New York. PWC recently scaled back its 2006 forecast of big bankruptcy cases, predicting just 88 instead of 95.

Last week, the credit-rating agency Standard & Poor's said the percentage of U.S. speculative-grade bonds that were "distressed" fell to 3.2 percent in July, the lowest level since May 1998. Speculative-grade defaults may rise slightly by the end of the year, "but the forecast is still very modest from a historical perspective," S&P said.

The low distress levels, analysts said, reflect the easy availability of money. Although the Federal Reserve has raised its key interest rate 17 times over the last two years, lifting it from 1 percent to 5.25 percent, yields on Treasury bonds haven't increased much. The 10-year Treasury note yielded 5.06 percent Wednesday.

High returns on investment — sometimes more than 20 percent — have attracted new types of investors in distressed debt, making it easy for troubled companies to borrow their way out of a crisis. Hedge funds and private-equity firms have played a growing role as financiers of troubled companies in recent years.

"Borrowers are able to find a new lender to take them out of whatever their current problem is," said Penn, the former ABI president who now works for the Haynes & Boone law firm in Texas. "The lenders and the hedge funds have money that they have to put to work."

S&P considers a company to be "distressed" when its bonds yield more than 10 percentage points above a Treasury note. But few companies meet that definition. The average for speculative-grade bonds was a spread of just 3.5 percentage points over Treasurys in mid-July.

S&P, as a result, said conventional definitions of financial distress may have become less reliable recently.

Diane Vazza, an S&P managing director, said the agency recently opted to expand the definition in an attempt to identify companies and industries that "could experience distress when lending standards are tightened more meaningfully."

When the threshold spread was reduced to 6 to 8 percentage points above Treasurys, she said, S&P's list captured such companies as General Motors Corp.; Ford Holdings Inc., a finance subsidiary of Ford Motor Co.; and Bally Total Fitness Holding Corp.

Turnaround professionals, bankruptcy experts and distressed-debt analysts agree that troubled companies can't indefinitely avoid a restructuring. Eventually, they say, both the volume of bankruptcy filings and the amount of corporate restructuring work will rebound.

"There will always be insolvencies. There will always be business failures. There will always be fraud," said Ray Warner," a bankruptcy-law professor at St. John's University in Queens, N.Y. The next "boom" in bankruptcy restructurings, he said, will occur "when you finally see upheaval in the hedge-fund industry."

Most experts, however, said the reckoning is likely to occur gradually.

"Something is going to happen that will dry up the liquidity," said Penn of Haynes & Boone. "I don't know if it's going to be an event, or we'll all just wake up one day and say, 'Where did the money go?' "