FOR TROUBLED FIRMS, A FLOOD OF BIG LOANS

They Gain Time to Fix Woes---or Delay a Fix; Hedge Funds Play Role

By Bernard Wysocki Jr.

Bally Total Fitness Holding Corp., a Chicago health-club operator, is
deep in debt and has periodically been considered a candidate for
bankruptcy.

That didn't prevent Bally from borrowing $284 million last October.  A
unit of JP Morgan Chase & Co. arranged the loan, with investment banks
and a hedge fund participating.

"I'll never forget being in a board meeting and saying to our
investment bankers:  "How on God's earth was this so easy?" says
Steven Rogers, a finance professor at Northwestern University who was
then a Bally director.  "They said:  'There's a lot of money out
there.'"

In a world awash in investable funds, even many of the most troubled
companies are finding lenders willing to offer them big money.  This
rescue financing, as it is sometimes called, can give companies time
to clean up their balance sheets and avoid a trip to bankruptcy
court.  US
filings for bankruptcy reorganizations---a painful experience for
employees, creditors and shareholders alike---are at a 10-year low.
Also at historic lows are US corporations' debt defaults.

Rescue financing gives the economy more flexibility to work through
some of its problems, says Dhruv Narain of Goldman Sachs Group Inc.
"Today, a lot of this is being done out of court, outside of Chapter
11," says Mr. Narain, co-head of the US restructuring group at
Goldman, a big player in emergency financing.

But some worry that all the money flowing to troubled companies deters
them from solving their problems.  It just lets them "kick the can
down the road," says William Derrough, co-head of recapitalization and
restructuring at investment bank Jefferies & Co.

It can also be risky to have so much debt sloshing around the
economy's shakier regions.  When rescue lending fails, the extra debt
can make a bust just more spectacular.  Among lenders that risk taking
it on the chin are hedge funds, which have largely replaced banks as
lenders in this kind of finance.  Says Mr. Derrough:  "To quote Alan
Greenspan, there's some irrational exuberance on the part of
investors."

How and when the credit cycle might turn isn't known.  But nearly all
economists believe that interest rates will eventually rise for loans
on risky assets.  Lenders will become more cautious and the result
will be tighter credit, possibly even a so-called credit crunch....

Rescue money can come in the form of bonds or even equity infusions,
but many of the recent deals involve credits known as leveraged
loans---those carrying interest rates of at least 1 1/4 to
1 1/2 percentage points above the London interbank offered rate, or
Libor.  This leveraged-loan market is booming.  It has tripled over
five years to $500 billion....A slice of this sume is rescue
financing....Leveraged loans are often used in buyouts that load up
companies with debt, and more such loans could be injected as "rescue"
finance if companies hit trouble.

The Federal Reserve is watching the leveraged-loan market as an "area
of possible financial risk," a Fed governor, Randall S. Kroszner, said
in a recent speech.  He said the Fed was "mindful that high levels of
leverage can lead to credit problems relatively quickly for both
borrowers and lenders when conditions turn."

The frothy late-1980s era of high-yield "junk" bonds gave way in the
early 1990s to a recession, the collapse of the savings-and-loans and
the downfall of the main junk-bond underwriter, Drexel Burnham Lambert
Inc.  A severe credit crunch ensued, with all but blue-chip companies
having trouble securing debt funding.

In 1998, a crisis at hedge fund Long Term Capital Management, amid
turmoil in global debt markets, brought on a milder credit squeeze.
Three years later the combination of the dot-com meltdown, another
recession and the Sept. 11, 2001 terrorist attacks led to a wave of
bond defaults....

The Bally case illustrates that in today's Wall Street, a slew of bad
news over a period of several years doesn't preclude a company from
raising large amounts of cash that give it another chance to work out
its problems.

Bally, an operator of nearly 400 fitness centers...has posted big
operating losses as its membership revenue has declined.  It piled up
a mountain of debt, more than $800 million....

In 2006, as losses mounted and the stock fell, Bally's chief executive
departed.  The company named a former Bear Stearns investment banker,
Donald Kornstein, as chairman.  In late 2006, Bally concluded it
couldn't make a crucial debt payment.

The $284 million loan JP Morgan then arranged helped Bally dodge that
bullet.  It pushed the company's next deadline---on $300 million of
debt---forward six months to next October....

"Thanks to an electric jolt to its economic heart, Bally came back to
life..." wrote Peter Cohan, a Babson College business professor, in a
blog which he recommened selling Bally stock short, or betting on a
decline.

The help was short-lived.  In March, Bally didn't file its 2006
financial statements on time.  The New York Stock Exchange delisted
its shares after the price fell below $1....With the October deadline
looming...Mr. Kornstein started intensive talks with Bally's largest
stockholders and variosu creditors.  On May 31, Bally announced a
complex plan, approved by key creditors, under which it would go
private after a quick trip to bankruptcy court.

The filing would wipe out existing shareholders and reduce debt by
$150 million....Mr. Kornstein declined to be interviewed.  He hailed
the agreement in a written statement, noting it wold cut Bally's
annual interest bill by $29 million.  Bally's announcement said "while
the company is in the process of restructuring, investments in its
securities will be highly speculative."

The announcement was a reminder that while some rescue loans clearly
work...others are at least partial failures...