Some might describe
it as paradoxical, Daliesque, or poetic justice when a company whose
liabilities far outweigh its assets can't get the financing it needs to
declare Chapter 11 bankruptcy.
Regardless, it says
something about the alleged recovery in credit and other markets that some
optimistic analysts claim is on the horizon (as well as the overall state of
the economy) when lenders who have top priority in such proceedings are
unwilling (or unable) to stump up the cash.
In "Liquidation Risk Grows as Finance Dries Up," the Financial Times reports on the
US companies face a greater risk
of liquidation because sources of finance to let them reorganise under the
country’s bankruptcy code are drying up in the global financial crisis.
In the US, companies on the verge of insolvency can restructure themselves under a Chapter 11
bankruptcy protection process, sometimes taking years.
But the credit crunch
has severely limited the availability of so-called ‘debtor in
possession’ financing that is vital to give them this second chance.
With previous big
providers of DIP financing, such as GE Capital, shying away from the market,
companies may have to rely on their existing lenders, says Standard &
Poor’s, the rating agency.
It said on Friday
there had been no substantial increase in DIP volumes in 2008, in spite of a
jump in the number of bankruptcies, highlighting the reluctance of banks and
investors to finance companies in bankruptcy.
Steven Smith, global
head of leveraged finance and restructuring at UBS in New York, said this
cycle was likely to see more liquidations than in the last three combined.
He said: “The
lack of DIP financing available is an issue for the American economy because
of the potential job destruction that could result.”
Lenders, even those
with priority claims, face big losses, if a company cannot reorganise and
Senior lenders to
retail companies would recover less than half of what they would if the
company reorganised under Chapter 11, according to S&P.
Debtors also face the
highest rates yet for DIP financing. The risk premium a debtor has to pay on
the loan has more than doubled since 2001-2002, the height of the last
downturn, according to Dealogic.
In 2001 the spread
over Libor was 429bp versus 900bp now.
Most companies are
trying to delay Chapter 11 as long as they can, said Mr Smith. Once in
Chapter 11 it was not certain they would get financing.
Other companies have
been contemplating pre-emptive bankruptcies while they still have cash, to
improve their chances of an organised restructuring. Analysts speculated this
was the case with Nortel Networks, the Canadian telecoms equipment maker which
filed for Chapter 11 earlier this month.
Companies have also
been looking to avoid Chapter 11 by using a debt exchange, where creditors
are asked to accept concessions to reorganise debt outside the courts.
Michael J. Panzner
Michael J. Panzner is a
25-year veteran of the global stock, bond, and currency markets and the author
of Financial Armageddon: Protecting Your Future from Four Impending
Catastrophes, published by Kaplan Publishing.