Capital Markets

Subprime Crisis Foments Bankruptcy Surge

Jones Day study shows Chap. 11 filings hitting 6,237 last year, up from 5,010.
Stephen TaubMarch 12, 2008

The subprime mortgage crisis, best known for causing a flood of foreclosures and drastically tightening credit markets, also had a huge impact on the bankruptcies last year. And the trend is expected to continue in 2008, according to a new study from the law firm Jones Day.

The study notes that Chapter 11 filings hit 6,237 in 2007, up from 5,010 the prior year. Jones Day cites a report compiled by Jupiter eSources LLC. Altogether, 78 publicly traded companies filed for bankruptcy protection last year, compared to the 66 public cases filed in 2006.

What’s more, 4 of the 10 largest bankruptcy filings in 2007 were direct casualties of the subprime mortgage meltdown, according to the Jones Day report, which adds that already, 50 subprime lenders have either folded, filed for bankruptcy, or closed their doors by liquidating their mortgage inventory.

Indeed, the largest public bankruptcy filing in 2007 — and the ninth-biggest public bankruptcy filing of all time — was by subprime lender New Century Financial Corp., once the second-largest provider of home loans to high-risk borrowers in the U.S. It filed for Chapter 11 protection last April 2.

The second largest bankruptcy filing was made by American Home Mortgage Investment Corp., another major player in the subprime mortgage lending business.

The fourth-largest public bankruptcy case of 2007 was filed by Delta Financial Corp., the subprime lender that filed for Chapter 11 protection in December 17 after a financing deal with alternative asset management firm Angelo, Gordon & Co. collapsed because the derivatives market rejected Delta Financial’s efforts to securitize $500 million in nonconforming loans.

And the fifth largest public company bankruptcy filing was NetBank Inc., an internet-only savings and loan that filed for Chapter 11 protection in September hours after federal regulators shut down its online financial subsidiary due to problems associated with its home mortgage loans.

The tightened credit markets also impeded some already bankrupt companies to emerge from Chapter 11, according to the report. These companies include Dura Automotive Systems Inc., Delphi Corp., and Calpine Corp., all of which were forced to postpone their emergence from bankruptcy due to the difficulty in lining up exit financing in the current hostile credit environment, according to Jones Day.

The ramifications of the subprime disaster are likely to manifest themselves well into 2008 and perhaps beyond, the report asserts. It added that 2007 — marked only the beginning of the problem — as default rates on subprime loans began to soar and financial institutions started to call in their loans.

It notes that companies involved in the subprime disaster have already wiped more than $170 billion from their books. But, it warns that this already staggering number may be more than doubled by the middle of 2008, when defaults peak and home foreclosures mount as interest rates on subprime mortgages reset.

With the specter of recession looming on the horizon, Jones Day says the homebuilding and building-products industries are obvious candidates to most likely to be hardest hit by these developments. Other industries that could surely suffer from the fallout include the retail and consumer-product sectors as well as the music and entertainment and restaurant industries.