Restructuring

Contributed by Amy B. Price
“Never forecast. But if you do, never put it in writing. But if you do, do it frequently, and revise.”  Dr. Edward I. Altman (quoting unknown source) 
On March 16, 2011, Weil, together with Charles River Associates, hosted Dr. Edward I. Altman, the Max L. Heine Professor of Finance at the Stern School of Business, New York University, for an exclusive lecture entitled “Current Conditions and Outlook for Global Corporate and Sovereign Debt Markets,” at Weil’s New York office.
In addition to serving as Director of the Credit and Fixed Income Research Program at the NYU Salomon Center, Dr. Altman has an international reputation as an expert on corporate bankruptcy, high yield bonds, distressed debt and credit risk analysis.  Among Dr. Altman’s many accolades, he was named Laureate 1984 by the Hautes Études Commerciales Foundation in Paris and awarded the Graham and Dodd Scroll for 1985 by the Financial Analysts Federation for his work on default rates and high yield corporate debt.  In 2005, he was named one of the “100 Most Influential People in Finance” by Treasury & Risk Management magazine.
Dr. Altman’s presentation began with an overview of U.S. credit markets, focusing on the high yield bond market over the past several years as a backdrop for discussing where credit markets stand today and where he predicts they will go in the future.  He emphasized that we are currently enjoying a “benign” credit cycle.  In particular, new credit is readily available, the terms are favorable, and there are ample opportunities to refinance existing debt.  Not surprisingly, Dr. Altman reminds us that indiscriminately lending to companies of all types today will have consequences tomorrow.  Though, relatively speaking, the financial system has stepped out from under the shadow of the unwieldy derivatives market for CDOs that loomed over the system in 2007, fears of another meltdown in the future are not unwarranted.  Indeed, Dr. Altman portends that the advantages of today’s low interest rates and high liquidity will come at a price, as short term interests do not always align with long term goals.  That said, at least for the next 12 to 18 months, Dr. Altman echoes (although tempers) the Fed’s optimism that a double-dip recession is unlikely.  The true test will come during 2013 and 2014, when large volumes of private and public debt maturities are scheduled to become due.  The level of liquidity in the markets at that time will make or break us.
In the mean time, Dr. Altman advocates applying his bankruptcy prediction tools to understand and prepare for risk, and better yet, to manage financial turnarounds and stave off distressed situations.  Although his financial distress prediction models are frequently used by lenders, investors, analysts, and M&A advisors, among others, Dr. Altman envisions corporate managers actively applying his models to correct and maintain a company’s financial health.  If management can keep companies within Dr. Altman’s statistical safe zones, in turn, credit constituencies will be more willing to lend to these companies, at once shielding them from the dangers of another liquidity crisis and facilitating the ultimate drive to produce shareholder returns.
As to financial distress predictions on a global scale, it is only natural that Dr. Altman, the master of modeling, would try his hand at reconceptualizing distress in global sovereign debt markets.  Rather than joining the flock of financial theorists who have approached the sovereign debt crisis from the top down, focusing on macroeconomic factors and data produced by central banks and bank economists, Dr. Altman’s idea is to look at sovereign debt from the bottom up – by estimating the default probability of a given sovereign based on the aggregate default probabilities of its private sector companies.  By combining macro data with micro data on the health of sovereigns, Dr. Altman believes he can more accurately gauge future risk in global sovereign debt markets.  Discovering a new portal into the future, however, is not the same thing as solving the problems that plague and will continue to plague over-leveraged countries.  Indeed, Dr. Altman views the restructuring of Greece as inevitable, despite bailout efforts over the next few years.  Moreover, to his audience’s surprise, Dr. Altman pointed to Italy as Europe’s “fulcrum country.”  In other words, Italy’s financial viability can ultimately seal the fate of the Euro.  Although Spain maintains a symbolic lead role in supporting the Euro’s sustainability, Spain’s $600B in debt does not compare to Italy’s $2T debt load, in terms of the European Central Bank’s ability to fund a bailout if needed.
In an earlier Blog post, we asked readers to look into their crystal balls.  But Dr. Altman’s prophetic magic offers something even better – statistical models.  Not only does he have logical equations on his side, but Dr. Altman also has a deep understanding of how risk factors, both quantifiable and unquantifiable, can dramatically impact the credit markets.  We can only hope that he will continue to enlighten the financial community and the world at large by sharing his prediction tools.  You can view Dr. Altman’s slides by clicking on this link.