Troubled Companies Winning Lifelines in ‘Fragile’ Market

While U.S. icons from Hostess Brands Inc. to Eastman Kodak Co. succumb to bankruptcy, credit markets awash with cash are allowing many of the riskiest companies to stay afloat, pushing off restructurings and raising the stakes for investors pursuing higher returns.

Junk-bond sales soared to a record last year and speculative-grade borrowers raised the most in loans since the 2007 peak, while business bankruptcies fell 22.4 percent to 57,500 compared with 2011. Chapter 11 cases, where companies reorganize or sell assets, dropped by 12.4 percent, according to data compiled from court records by Epiq Systems Inc. At the same time, storied U.S. brands struggling with legacy liabilities and outdated products proved vulnerable.

The pursuit of yield is creating a “fragile” market position that may unravel should investors get spooked by an unexpected shock such as political upheaval or natural disaster, said Flip Huffard, a senior managing director at Blackstone Group LP’s restructuring unit.

“That can dramatically change the market overnight,” Huffard said at a Turnaround Management Association event held in New York on Jan. 24. Eventually troubled companies that refinance multiple times will reach “the end of the line and they actually need to fix their capital structures.”

Sectors likely to pursue restructuring in 2013 include energy, shipping, media and mid-market companies dependent on U.S. government contracts, such as defense and health care, according to turnaround experts on the TMA panel.

Search for Yield

Investors seeking better returns sent sales of high-yield bonds soaring 45 percent last year to a record $354.2 billion, according to data compiled by Bloomberg. Junk bonds returned 15.583 percent last year -- up from 4.383 percent in 2011 -- according to the Bank of America Merrill Lynch U.S. High Yield Index. Bonds of distressed companies have returned 231 percent since the end of 2008, compared with 122 percent from high-yield corporate bonds, the data show.

“Extend and pretend -- both in the leveraged loan market and the high yield bond market -- is bailing out just about anybody,” Edward Altman, a finance professor at New York University’s Stern School of Business, who created the Z-Score measure for bankruptcy risk, told TMA. “We shouldn’t have this situation where money is so easy, and have cheap rates for questionable companies.”

Record Sales

Companies last year sold a record $58 billion of bonds in the U.S. ranked between the equivalent of CCC+ and C by Moody’s Investors Service, Standard & Poor’s and Fitch Ratings, according to data compiled by Bloomberg. That exceeds the $55 billion of such debt issued in 2007 and is triple the $19 billion sold in 2009. About $6 billion has been sold in January.

Loans made to the neediest U.S. companies rose in 2012 to the most in five years, with speculative-grade borrowers raising more than $315 billion of the debt from collateralized loan obligations and hedge funds, according to data compiled by Bloomberg and JPMorgan Chase & Co. That is the most since $388.3 billion was issued in 2007.

Energy Future

Energy Future Holdings Corp., the power company formerly known as TXU Corp. taken private in a record $43.2 billion leveraged buyout, persuaded creditors to exchange bonds and extend a revolving credit facility in the past month, even as Moody’s Investors Service warned the company faces a “material restructuring” in the next six to 12 months.

While such companies are finding credit to stay afloat, some of America’s oldest corporations including Kodak, Hostess, and American Airlines turned to bankruptcy. Saddled with so-called legacy liabilities including union contracts and underfunded pension obligations, they were unable to overcome the sluggish economy and management failure to keep pace with changing consumer tastes.

“Companies that have legacy obligations are saying it just can’t be cured unless they have a formal restructuring,” Harvey Miller, the Weil Gotshal & Manges LLP restructuring partner who handled the bankruptcies for Lehman Brothers Holdings Inc. and General Motors Corp., said in an interview. “The pigeons have come home to roost as the economy slowed down.”

Kodak Bankruptcy

The 132-year-old Kodak filed for bankruptcy in January 2012 after years of burning through cash while the rise of digital photography ruined its film business. Chief Executive Officer Antonio Perez has been selling businesses to shrink Kodak and fund its shift into commercial printing and packaging.

The Hostess bankruptcy, also filed in January 2012, turned into a liquidation of the 82-year-old maker of Twinkies, Ho Hos and Ding Dongs in November, after the company failed to reach agreement with its striking bakers’ union on concessions. The union blamed management for failing to modernize and said it had accepted big wage and benefit reductions after Hostess’s first bankruptcy, from which it emerged in 2009. Changes in American diets led to years of declining sales at Hostess, which is now selling off brands, recipes, plants and other assets.

AMR, parent of American Airlines, filed for bankruptcy in November 2011, the final large U.S. full-fare airline to seek court protection from creditors. It has won $1.06 billion a year in concessions from workers and now nears a decision on merging with US Airways Group Inc. or exiting bankruptcy on its own.

Pension Problems

“When you see these older names face financial problems, they often have liabilities that can’t be easily addressed with typical refinancing markets that Wall Street can provide,” David Ying, senior managing director and head of restructuring at Evercore Partners Inc., said in an interview. For companies without such legacy liabilities, “there’s plenty of liquidity in the markets,” he said.

Low interest rates tend to hurt companies with large pension liabilities because of how future retirement obligations are accounted for, according to bankruptcy experts. Companies can’t as easily discount future pension liabilities, resulting in larger near-term funding obligations, said Damian Schaible, a partner in Davis Polk & Wardwell LLP’s insolvency and restructuring group.

The weak economy over the past couple of years meant the companies were “not making as much money to fill those pension and legacy liability holes,” Schaible said in an interview.

“The suppression of interest rates by the Federal Reserve allowed many companies which otherwise might have restructured to push out their problems by several years,” Ken Buckfire, head of New York-based restructuring firm Miller Buckfire & Co., now a unit of Stifel Financial Corp., said in an interview. “The companies that were forced to do a real restructuring, especially in bankruptcy, were generally companies that because of failing business models or other unique challenges, had no other option.”

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