Lenders more willing to own bankrupt firms

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By Tom Hals - Analysis | 11 February 2010 @ 07:22 am EDT

WILMINGTON - U.S. lenders are becoming increasingly willing to take over bankrupt borrowers --- a significant shift from last year, when companies like Chrysler and Eddie Bauer were pushed to a quick sale.

The change reflects a more stable economy, rising asset prices and fewer bankruptcies involving companies that have simply run out of money.

"A year ago there was no turning around of anything. It was get whatever cash you can get out," said Jerry Mozian, of the turnaround management firm Tatum. He said banks now see little value in forcing a sale.

Recently, the publisher of Reader's Digest, pool maker Latham International and Natural Products Group, which owns the Nature's Gate line of organic soaps, have filed for bankruptcy with plans to transfer most of the equity to secured lenders.

Bankruptcies a year ago "were situations that needed extremely fast resolution and someone willing to write a check," said James Sprayregen of Kirkland & Ellis, which represented Reader's Digest Association Inc RPPLER.UL.

"The prearranged plans we're seeing now, in general, are more operationally healthy companies with overleveraged balance sheets where there may not be a liquidity problem," he said.

The recession that began two years ago has already sent the weakest companies through bankruptcy.

In addition, many secured lenders, which in any large bankruptcy includes banks that originated a loan as well as hedge funds and other investors who buy portions of it, are no longer facing concerns about their own levels of cash.

That gives them the luxury to hold an ownership stake in a company until better times.

Lenders typically seek to take over companies where the assets are worth less than the secured debt, leaving other creditors with little chance of a recovery.

The holders of secured debt are most likely to have an interest in companies that are perceived to be at the bottom of the cycle in their industry, the worst time for a quick sale.

For senior creditors, the conditions that make owning a bankrupt company attractive also raise a potential problem: junior creditors who argue that a stronger economy and financial markets justifies giving them a larger payout.

Lenders have tried to fend off those challenges by offering some payout to junior creditors and by giving them ways to cash in on a potential rebound through stock options and warrants.

"If it turns out there's more value, they share in the upside," said Sprayregen.

Even in industries where there is little prospect of a turnaround any time soon, holders of secured debt may be more willing to own the business.

In the media industry, for example, a number of bankrupt companies have proposed transferring a significant portion of their stock to secured lenders in exchange for reducing debt, including the publishers of the Orange County Register, Minneapolis Star Tribune and Denver Post.

Dan Bender of AEG Partners, a turnaround management firm in Chicago, said the media industry suffers from depressed values and secured debt holders have little expectation of a recovery on their loans.

"They worry their position is getting worse. So they step in and run it," he said.

That, in turn, is having an impact on restructuring work.

Until recently, lenders brought in turnaround professionals to fix balance sheets of borrowers, with little attention given to a business model.

"No one ever washes a rental car," said Sheon Karol of CRG Partners, a turnaround management firm in New York. "When lenders own the companies, they want specialists to come in and improve the way businesses are run."

(Reporting by Tom Hals; Editing by Tim Dobbyn)