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Coming Business Bankruptcy Cycle to be Characterized by Smaller Market Busts

June 6, 2005, Alexandria, Va. —  The next bankruptcy cycle may not begin until 2006, according to an article published in the American Bankruptcy Institute’s Journal. But when it begins, it will be distinctly different from 2001-02 in several critical respects, John Yozzo of FTI Consulting Inc. (New York) and Sean A. Gumbs of FTI Palladium Partners (New York) point out in Intrepid Credit Markets Have Everyone Smiling...for Now.

In contrast to the mega-bankruptcies of 2001-02, the next default cycle will be filled with smaller middle-market bankruptcies, particularly broken LBOs and other sponsored-backed deals.  

The surge in asset-based lending, especially if it continues, will prompt secured lenders to get actively involved in troubled credits sooner and move more quickly to protect collateral values, even if that means precipitating a reorganization, in or out of court.

Arranging for DIP financing in such an environment will be a daunting challenge for debtors whose assets are already highly encumbered going into bankruptcy. Quick sales of businesses and assets are more likely to ensue.

Holders of second-lien loans will likely see lower recoveries in default than they had anticipated going into these deals.

Getting restructuring professionals involved in a deteriorating situation earlier—when there is a wider range of restructuring options—will, more than ever, be critical to successful turnarounds.

In the wake of the fast pace of debt defaults in 2001 and 2002, particularly those resulting from the telecom bust and a few big corporate bankruptcies, debt defaults and restructurings moderated significantly in 2003. The following year was marked by strong earnings growth and expansion for American business and one of risk-taking in the capital markets. It was a remarkably bullish year for the loan and bond markets, in particular. Credit markets continued to expand, facilitated by thriving borrows and liberal lenders. Rating agencies expect default rates around the relatively low 2.7 percent range by year end, but the seeds of the next bankruptcy cycle have been planted.

Read the full article.


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