Distressed debt exchanges on the rise

By Anastasija Johnson - Analysis

NEW YORK (Reuters) - More companies will be forced to turn to bondholders this year to delay paying debt coming due as they struggle to turn around businesses in a weakening economy.

This leaves bondholders with a stark choice: let a company pay later and help it stay afloat or push it into bankruptcy and potentially recover only a small fraction of what they had lent.

So far, bondholders in GMAC'S LLC money-losing mortgage finance unit Residential Capital, theme park operator Six Flags Inc (SIX.N: Quote, Profile, Research, Stock Buzz), yellow pages directories publisher R.H. Donnelley Corp (RHD.N: Quote, Profile, Research, Stock Buzz), and newsprint producer AbitibiBowater Inc (ABH.N: Quote, Profile, Research, Stock Buzz) (ABH.TO: Quote, Profile, Research, Stock Buzz) have had to make that choice.

These companies asked bondholders to exchange existing debt for longer-dated new bonds to avoid running out of cash. Some also asked bondholders to forgive a portion of old debt, while offering incentives such as better security and higher interest on new debt.

"This is one way historically that a company can avoid bankruptcy," said Kenneth Emery, senior vice president at Moody's Investors Service in New York.

Rating companies consider these offers a technical default because bondholders are often not repaid in full.

Historically, distressed debt exchanges represent about 10 percent of all defaults, but this year they have increased to 15 percent to 20 percent as companies face tough economic conditions, Emery said.

"This year we've seen the number of issuers defaulting increase significantly over last year, so we've seen an uptick in distressed exchanges as well," Emery said.