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Poised for bankruptcy surge

The Baltimore Sun

CHICAGO -- Business bankruptcy filings are down by 45 percent and corporate debt default rates remain near all-time lows. Yet bankruptcy pros are buzzing with anticipation.

While they don't have crystal balls, call them cynical and firm believers in business cycles. Lawyers, consultants and financial advisers who work with troubled companies are getting ready for the next surge in business, which some predict may come as soon as the end of this year.

"My experience over the last 20 years is that what goes up, must come down," said Jeff Marwil, a Chicago attorney who last month joined Winston & Strawn's larger bankruptcy practice. "Change is inevitable."

The credit markets that Marwil and his peers closely watch are enjoying one of the biggest expansions in recent history. Companies are borrowing cheaply, as banks and investors such as hedge funds are eager to lend. That has resulted in a flurry of debt-driven corporate mergers, spinoffs and buyouts.

It also means that struggling companies are more able to refinance their debt and delay fixing operational problems. One sign that the financial system is flush with cash: Business bankruptcy filings through the first nine months of 2006 totaled 14,228, compared with 26,275 in the comparable period of 2005.

But some analysts are now warning that the good times could soon come to an end, meaning higher borrowing rates and more defaults - or what bankruptcy professionals like to call "inventory."

To prepare, some big law firms have bolstered their bankruptcy practices by cherry-picking prominent attorneys from other firms.

And an uptick in hiring also is happening outside the legal profession. A 2006 poll of more than 200 financial-advisory and consulting firms by the Turnaround Management Association found that 37 percent had added employees last year, compared with 32 percent in 2005.

In anticipation of the next wave of corporate restructurings, the association held its first-ever "Distressed Investing" conference last month in Las Vegas. The meeting, which brought together turnaround experts with financial dealmakers who buy securities in troubled companies, had everyone asking the same question that some outside the industry might consider grim: When is the bubble going to burst?

"The conference was a huge success," said Colin Cross, chairman of the Turnaround Management Association.

Bankruptcy and restructuring work has slowed from its last peak between 2000 and 2004, when practitioners were working at a fever pitch. The period featured bankruptcy reorganizations by United Airlines and two other major carriers, as well as the bankruptcies of scandal-plagued companies such as Enron Corp. and WorldCom Inc.

"Bankruptcy lawyers were in as high demand as they had been in the last 20 years," said Michael Solow, a Chicago attorney at Kaye Scholer.

In response to economic and corporate jitters after the 2001 terrorist attacks, the Federal Reserve dropped short-term interest rates as low as 1 percent in 2003. Rates have crept up to 5.25 percent, but debt remains cheap and corporate defaults have been virtually absent.

Defaults on U.S. junk bonds as a percentage of all junk bonds outstanding have fallen steadily since 2001 when they hit 10.5 percent, according to Standard & Poor's. Last year, the default rate was 1.26 percent, a 25-year low.

The cycle of falling default rates has lasted five years. With past cycles having turned within five to seven years, S&P; is predicting that the default rate will rise to 2.33 percent by the fourth quarter, said Diane Vazza, a managing director at S&P.;

Despite moderate growth in the overall economy, pockets of weakness remain in the auto, airline and housing sectors.

If defaults do rise, bankruptcy professionals expect to be very busy. The issuance of U.S. junk bonds, or high-yield corporate debt, has topped $100 billion in three of the last four years, levels not seen since the late 1990s.

Companies have rushed to the bond market to refinance. Buyout funds also are taking advantage of low borrowing rates to raise money for takeovers. About 40 percent of the junk bonds issued since 2004 are rated B- or below and have higher chances of default, Vazza said.

"All the available liquidity is papering over a lot of problems right now," Marwil said.

With companies leveraged to the max, there is little margin for error. Any blip - from a sharp rise in commodity prices to another terrorist attack in the U.S. - could lead to a crisis.

But, even though law firms are restructuring in anticipation, that won't necessarily mean an increase in bankruptcy filings in coming years, experts said.

New bankruptcy laws and the high cost of going to court will dissuade some companies, especially privately held ones, from making public filings, said bankruptcy attorney Richard Chesley, who left one firm for another in November.

"I think people are positioning themselves for a different market," Chesley said. "I think we're going to see more out-of-court settlements, especially among portfolio companies of the private-equity firms."

Ameet Sachdev writes for the Chicago Tribune.

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