The Coming Bankruptcy Wave?

One of our firm’s founders passed along a sunny piece from last week’s The Deal.  At 28 years in the business, this is not a triumph-of-hope-over-opportunity kinda guy.  On the article was scribbled, “some facts to go with my doom & gloom.”  I only have the hard copy, but its authors are Rovit and Schaar, two guys in Bain’s turnaround group.

Some facts, these, and the analysis that goes with them is worse still:

-The benign cycle in bankruptcies has lasted a long time.  In 2007, bankruptcies were 5% lower than in 1990.

-The authors’ analysis shows that this period is over, and “speculative-grade debt defaults will increase in the U.S. by 5 to 10 times over 24 months.”  The authors go on to say that many of these defaults will be in companies you’ve heard of, and that the ripple effect on the economy will be meaningful.

-They note that “typically, two-thirds to three-quarters of defaults end in bankruptcies within three months.  That converts from 50 to 75 bankruptcies in 2008, and 85 to 100 in 2009, compared to 13 in all of 2007.

-As a result of the especially easy credit markets in 2006-7, the true damage will take longer than usual to assess.  “Covenant lite loans, which lack the normal fianancial circuit breakers to ensure lenders get repaid, have risen from almost nothing in 2005 to about $97 billion in 2007, or nearly 20% of all the leveraged loans issued.”

-When those covenant-lite chickens are looking to roost, the volume will be staggering:  “with the growth in maturing issuances forecast to jump 43% annually, from $26 billion in 2008 to $76 billion in 2011….Thus the firms that navigate the difficult waters over the next 24 months will face a second challenge when it comes time to as banks ratchet down their leverage ratiosfrom their peak of 6.2x in 2007.”

Assuming the credit markets are at their normal 2.5-3.5x leverage for these assets, when refinancing becomes required, there’s gonna be a whole lotta pain to go around.


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