Wave of Coming Bankruptcies Likely to Devastate Corporate Bondholders

Bondholders Lucky to Get 10 Cents in Looming Defaults
By Caroline Salas

April 23 (Bloomberg) -- The looming wave of bankruptcies is unlikely to be kind to bondholders. And they have only themselves to blame.

Rather than receiving the historical average recovery of 42 cents on the dollar in a default, owners of a third of high- yield, high-risk bonds rated B+ or lower may get no more than 10 cents, according to New York-based Fitch Ratings. About 22 percent are likely to get 11 cents to 30 cents.

Bond investors from Pacific Investment Management Co. to Capital Research & Management Co. may pay the price for allowing themselves to be subordinated by junk-rated companies that borrowed a record $2.2 trillion of bank loans in the past three years. Unsecured creditors of Fedders Corp. and Buffets Inc. have lost almost all their money as lenders lay claim to the companies' assets. Standard & Poor's says Burlington Coat Factory Warehouse Corp. and Univision Communications Inc. bondholders may meet a similar fate in a default.

''There've been some disappointments,'' Paul Scanlon, team leader for U.S. high yield and bank debt at Putnam Investments, said in a telephone interview from his Boston office. Putnam manages $66 billion in fixed-income, including bonds of Univision. ''As people look back over the last 24 months, there are many transactions in portfolios that people have hoped the outcome might have proceeded differently than it has.''

More Crucial

Bondholder recovery rates are becoming more crucial as the U.S. economy slows. Chapter 11 business bankruptcies rose 16 percent in the first quarter, according to court records compiled by Jupiter eSources LLC, and Moody's Investors Service said last week that the number of companies at risk of running out of cash is the highest since at least October 2002.

''When leverage was so ample, private equity firms were able to buy companies at multiples that didn't make sense,'' said James Keenan, who oversees $20 billion of high-yield debt as co- head of leveraged finance at BlackRock Inc. in New York. ''Most people use the assumption senior unsecured bonds are going to recover 40 percent. I don't think you're going to see that.''

The amount of debt in Merrill Lynch & Co.'s U.S. High Yield Distressed Index has swelled to $206 billion from $4.8 billion a year ago. The index contains non-defaulted bonds with yields of 10 percentage points or more above Treasuries.

Defaults to Rise

Moody's anticipates defaults will quadruple to 5.9 percent in 12 months. That assumes a ''mild'' recession. Judging by the amount of distressed debt, investors expect an 8 percent default rate, said Martin Fridson, head of high-yield research firm FridsonVision LLC in New York.

''I'm inclined to take the market at its word,'' said Fridson, who previously led a research group at Merrill that won first place for high-yield strategy in Institutional Investor's survey nine years in a row.

Junk bonds lost 3 percent in the first quarter, the worst start to a year on record, according to Merrill's U.S. High Yield Master II Index. The extra yield, or spread, investors demand to own the debt instead of Treasuries has risen to 7.07 percentage points from 5.92 percentage points at year-end, Merrill data show. High-yield, or junk, debt is rated below Baa3 by Moody's and lower than BBB- by S&P and Fitch.

Of about 100 issuers rated B+ and lower by Fitch, 24 percent may recover 51 cents on the dollar or more. B+ is the fourth- highest of 12 junk bond levels. Asset-rich companies such as Dallas-based Energy Future Holdings Corp., the former TXU Corp., which is the largest electricity producer in Texas, may be among those that would generate above-average recoveries, Keenan said.

Covenant-Lite

Along with the surge in bank loans came covenant-lite loans, which typically don't limit the amount of debt a company can have relative to earnings. A record $141 billion of covenant-lite loans was made last year, according to S&P.

The value of companies with those loans is likely to be 25 percent less when they ultimately default than if they'd been forced to restructure earlier, Fitch estimates.

Univision, the largest U.S. Spanish-language broadcaster, received $7.45 billion of covenant-lite loans last year to finance the New York-based company's $12.3 billion takeover by a buyout group including Chicago-based Madison Dearborn Partners LLC and billionaire Haim Saban.

S&P, which cut Univision's credit rating to B- in March and may downgrade it further, predicts investors in its first-lien bank loans will get from 70 percent to 90 percent of their money back in a default while owners of Univision's $1.5 billion of 9.75 percent notes due in 2015 may get nothing.

Capital Research owns the Univision notes, which have lost about 31 percent in the past year, filings and data compiled by Bloomberg show. Abner Goldstine, fund manager at Los Angeles- based Capital Research, didn't return calls seeking comment.

Hawaiian, Burlington

As of Dec. 31, Goldstine's $12.2 billion American High- Income Trust also owns bonds of Burlington, New Jersey-based retailer Burlington Coat Factory, phone company Hawaiian Telcom Communications Inc. of Honolulu and mobile-phone chipmaker Freescale Semiconductor Inc. notes, based in Austin, Texas.

Pimco, the manager of the world's biggest bond fund, owns Hawaiian Telcom and Freescale. Putnam owns Freescale.

Bonds of all those companies are trading at distressed yields and noteholders will get no more than 10 cents on the dollar back in defaults, S&P predicts.

Mark Porterfield, spokesman for Pimco in Newport Beach, California, declined to comment. Putnam's Scanlon declined to comment on specific companies.

''Over the past few years you had a large growth of aggressive deals coming to market,'' said William May, senior director in credit market research at Fitch. ''The unsecured creditors are the ones who are most at risk.''

Limited Recoveries

Bondholders already face limited recoveries from companies that filed for bankruptcy.

Unsecured creditors of Liberty Corner, New Jersey-based air conditioner maker Fedders are suing lenders including Goldman Sachs Group Inc. and Highland Capital Management LP in addition to executives and directors. A $90 million loan taken out by the company in March 2007 wiped out the value of the stakes of creditors, they allege. Fedders filed for bankruptcy in August.

''They were saddling the company with secured debt that could never be repaid and the end game for them was prolongation of job security for upper management and putting off the inevitable,'' Jeremy Coffey, partner at Brown Rudnick Berlack Israels LLP in Boston, who represents unsecured creditors, said.

Goldman spokesman Michael Duvally declined to comment. Jack Yang, a partner at Highland, declined to comment.

Fedders Prelude

The Fedders fight may be a prelude to more battles between loan and bond investors as defaults rise. Typically, those spats have been reserved for subordinated bondholders, who rank behind bank lenders and the owners of senior notes.

''Whereas in the last recession it was more common perhaps to see the inter-creditor fights between subordinated unsecured creditors and the senior unsecured creditors, it may very well be that in this cycle that will have moved up a level in the priority chain,'' Andrew Rahl, a partner in commercial restructuring and bankruptcy at Reed Smith LLP in New York, said.

Stiglitz: Greenspan and Bush to Blame for the US Crisis

Its difficult to react to an excerpt from an unpublished interview.

Although we strongly agree with what he has said here, we are dumbfounded that there is no mention of the big US banks and Wall Street, who were engaging in serial fraud and corruption of the system going back to Enron and beyond, encouraging accounting fraud and reckless speculation. Greenspan and Bush were obvious figureheads and enablers, having accomplished little or nothing in their private lives before their moment on the stage.

Are we at the point we predicted when the real perpetrators start looking for scapegoats and patsies to toss over the back of the sled to hold off the oncoming pack of wolves?

If so, Greenspan and Bush make a likely pair of shallow boobs to take the fall. But it won't fix anything. And where were all the professors and pundits during the period in which this was all happening? Playing dumb for the most part, or putting out weighty sounding defenses of these offenses for a few pieces of silver.

The scapegoat phase is predictable but fruitless overall. The system must be reformed; the banks must be restrained again. The theft of the public good will continue until this occurs. They will distort every program, pollute every dollar of aid, to their continuing looting of the public trust.

There is a growing call in the US to pull one's money out of the big Wall Street banks. We're not sure about the effective of this, since it keeps the stock and bond markets intact, but its a start. Petitions for redress have been ignored. We've elected the Democrats and they have done far too little, waiting for the safety of a likely Democratic president. So now the time for boycotts has begun it appears.

The system must be reformed. Glass-Steagall must be reinstated. The Wall Street Banks must be restrained from using the public money to finance their private speculations. We must stop privatizing gains and socializing their losses.

Greenspan, Bush to blame for U.S. crisis: Stiglitz
Reuters
Sun Apr 27, 6:48 AM ET

Former Federal Reserve Chairman Alan Greenspan and the government of President George W. Bush were to blame for the U.S. financial crisis, Nobel laureate economist Joseph Stiglitz said in a magazine interview.

"This man (Greenspan) has unfortunately made a lot of mistakes," said former World Bank chief economist Stiglitz, according to a preview of the interview to be published on Monday in profil magazine.

"His first one was to support all the tax cuts which were introduced under Bush -- they didn't stimulate the economy very much ... This task was then transferred more towards monetary policy, though then (Greenspan) created a flood of credits with low interest rates," Stiglitz was quoted as saying.

Earlier in April, Greenspan said in an interview with CNBC television that the U.S. economy was in recession and defended his chairmanship of the U.S. central bank against charges that his policy missteps had laid the groundwork for the crisis.

He said decisions during his charge had been rationally constructed based on evidence at the time.

Stiglitz said Bush's government was also to blame.

"I reproach them, that the economy was not as resilient as it could have been due to the ongoing tax cuts and the huge costs incurred by the war in Iraq," he was quoted as saying.

He said it was a myth that Europe could decouple itself from the United States.

"Especially the weak dollar will continue to hit the European economy hard, because it will make it much harder to export," he said.

(Reporting by Karin Strohecker; Editing by David Holmes)

Greenspan, Bernanke, and Volcker: A Study in Contrasts

Here is an excerpt of an essay from Jeremy Grantham on the last three Fed chairmen that is worth reading.

The information about Alan Greenspan is entirely consistent with information we had received in a long correspondence with Pierre Rinfret before he passed away. Pierre was an economist who knew alan Greenspan from his time at NYU to their positions as colleagues in the Nixon Administration and afterwards.

The complete eight page essay requires a free registration here and can be downloaded here.

Immoral Hazard
Jeremy Grantham

Greenspan, Bernanke, and Volcker: A Study in Contrasts

It’s not that the former Fed boss Greenspan was incompetent
that is remarkable. Incompetence is common enough after
all, even in important jobs. What’s remarkable is that so
many people don’t seem, even now, to get it. Do people
just believe high-quality self-justifying blarney? Or is
it just that they apparently want to believe that critical
jobs in a great country attract great talent by divine right.

Sometimes, of course, they do, but sometimes the most
important jobs – even that of a presidency or a Fed boss
– end up with mediocrities. Let us pause here to regret
the absence of Mr. Volcker and wonder what a parallel
Volcker universe would have been like. Just as we can
wonder how much a few votes in Florida or a vote in the
Supreme Court would have changed our world from what
it is today.

Paul Volcker inherited about as big a mess as we have
today. He worked out what he had to do and did it with
unusual lack of concern about what Congress thought of
the necessary pain involved and the number of enemies
he might make. He paid the price for forthright behavior
by being replaced, despite a record for correct and tough
behavior that makes for the most invidious comparison
today. When Volcker was replaced, by the way, he did not
moan and groan but like an old soldier quietly disappeared.
There were no high-profi le announcements about the
economy or any $300,000-an-evening appearances paid
for by financial firms.

Greenspan came onto my radar screen in the late sixties as
a seller of economic and fi nancial advice to the investment
industry. To be brutally honest, he was considered run of
the mill by anyone I knew then or have met later who
knew his service then.

His high point in most memories,
certainly mine, was a famous call in January 1973 that, “it
is rare that you can be as unqualifiedly bullish as you now
can,” a few days before a market decline of over 60% in
real terms, second only to the Great Crash in a century,
accompanied also by a bitter recession.

This was one of the first of a long line of terrible prognostications for
which he has remarkably not been remembered, except
by a handful of us amateur historians. Then in the mid
seventies he disappeared into some government job, of
which I was barely aware, until he re-emerged with a bang
in 1987, without as far as I can find having done anything
documentably very well. And we can agree that at least
occasionally people can indeed prove their effectiveness
beyond doubt. This was obviously not the first or last
time such appointments were made where a job crying
for proof of character and achievement under pressure is
awarded more for what you might call political skills.

This has indeed not been our finest hour in the U.S. Times
are bad enough, in fact, to make us mourn the American
leadership skills of WWII and the generosity and foresight
of the Marshall Plan. We can all wonder at the incredible
vision, drive, organizational skill, and willingness to
sacrifi ce resources that were required by the Manhattan
Project and compare it to the rudderless or even deliberate
avoidance of leadership of the greatest issues today:
climate change and energy security. We can only wonder
what a Manhattan Project aimed at alternative energy
might have accomplished by now, had it been started 15
years ago.

What we have had in lieu of vision, leadership,
and backbone is a series of easy paths taken.

At the time that Paul Volcker broke the back of inflation in
the early 1980s, the recognition that risk and leverage had
consequences was baked into the pie: if you were to take
excessive risk you had better win the bet. If you missed
the target, the expected result would be more or less total
failure, and that seemed then and for decades earlier a
reasonable law of nature.

Now in contrast we get ready to celebrate the 20th
anniversary of the era of the Great Moral Hazard.
Slowly at first, but with steadily growing
traction, the idea was planted that asset bubbles would
be tolerated, but consequences of their bursting would be
moderated or avoided entirely...