US HIGH YIELD-Big bankruptcies down, recoveries up

By Dena Aubin

NEW YORK, Jan 22 (Reuters) - Big corporate bankruptcies fell to their lowest level in more than a decade in 2006, yet the golden era of scant default risk may be nearing a peak.

Last year, just 14 companies with assets of more than $100 million (in 1980 dollars) filed for bankruptcy protection, down from 25 in 2005 and the fewest since 1994 when there were 11, according to UCLA law professor Lynn LoPucki's Bankruptcy Research Database.

But some analysts think that's as good as it will get.

"What a lot of people feel is that bull markets don't go on forever, there are always cycles in the economy and that eventually there will be big defaults," said Matthew Dundon, head of research for Miller Tabak Roberts Securities in New York. "But the market's not voting that it will be any time soon."

Indeed, tight credit spreads, gains in the riskiest bonds and the hottest lending market in years all point to a sanguine attitude about default risk.

In another sign of optimism, the proportion of bonds that are distressed, or yield at least 10 percentage points more than Treasuries, is the lowest in the 16 years that Merrill Lynch has been tracking them.

"What is remarkable is how so many formerly distressed issues have just been snapped up by the market," said Christopher Garman, high-yield strategist for Merrill Lynch. "It's very indicative of really robust demand for yield and quite frankly not enough supply of new high-yield bonds."

Some strategists worry, however, that today's benign conditions are the calm before the storm. A key concern is debt being piled on healthy companies by a flood of leveraged buyouts.

DEFAULT IMPACTS MAY BE MUTED

"They're taking them substantially up on the risk chain by leveraging them," said Bill Featherston, managing director at J. Giordano Securities in Stamford, Connecticut. "Whenever their business starts to turn sour during the next down cycle, these are the companies that will be vulnerable to defaults."

For now, though, risk appetite remains hearty, and default trends may be one reason why. Though defaults are expected to edge higher this year, most the companies at risk are fairly small borrowers, and the damage to high-yield portfolios may be mild.

Only two of the 23 U.S. companies listed by Standard & Poor's as the likeliest candidates for default have over $1 billion in debt. The average debt for the group is about $384 billion.

S&P considers companies prone to default when they have a rating of "triple-C" or lower and credit quality looks likely to decline further.

Defaults among fairly small borrowers are unlikely to roil the credit markets the way that big bankruptcies of Enron and WorldCom did in 2001 and 2002, said John Lonski, chief economist for Moody's Investors Service.

"The default of a relatively obscure 'Caa-rated' company or several of them is perhaps not going to be the trigger mechanism that leads to a substantial widening of spreads and broadly distributed tightening of lending standards," he said. A "Caa" rating is Moody's equivalent of triple-C.

BONDHOLDER PAYOFFS RISE

Another reason for the bullish tone among risk takers is that they are recovering more when companies default. Average bond recovery rates were 64 percent last year, compared with 58 percent in 2005 and a long-term average of 40 percent, according to Fitch Ratings.

Auto parts supplier Delphi Corp.'s DPHIQ.PK 6.5 percent notes due in 2013, for example, have surged to 109.5 cents on the dollar from about 58 cents when it filed for bankruptcy in October 2005, according to MarketAxess. Northwest Airlines' NWACQ.PK 10 percent notes due 2009 have soared to 106.5 cents from 22.75 cents after it filed in September 2005.

Recoveries are high partly because companies involved in several large bankruptcies were not that financially weak to begin with, experts said.

"The biggest bankruptcies over the last couple of years have been labor-driven," said UCLA law professor Lynn LoPucki. "The purpose of the bankruptcy is to squeeze the unions either through their collective bargaining agreements or their pensions."

Investors have probably learned the lesson of missed opportunities in business busts, however.

"Even if we have some of these unpredictable or very surprising mega-cap bankruptcies in 07, what we're not likely to see is the market instinctively selling off," said Miller Tabak's Dundon. "You're probably going to see the market almost instinctively holding on."