Measure Heads Below 3%, From 14.6% Last Fall; ‘The Rebound Is Breathtaking’
The great debt storm has passed. And the damage is a lot less than feared.
Corporate debt-default rates are expected to fall to the same levels that preceded the financial crisis of September 2008, marking a swift turnaround for the fate of the most troubled U.S. companies.
The U.S. default rate should fall below 3% by year’s end, according to Moody’s Investors Service, a stunning drop from the 14.6% peak of November 2009 and even below the default rate of 3.1% from August 2008.
The default rate measures the percentage of companies with “junk” credit ratings that failed to meet debt obligations during a trailing 12-month period. The rate’s decline suggests the corporate bloodletting set off by the collapse of Lehman Brothers Holdings Inc. is at or near its end. That should bode well for the nation’s unemployment rolls, which swelled after the collapse of such companies as Circuit City Stores Inc., Linens N’ Things Inc., and Nortel Networks Corp. in 2008 and 2009.
“In the near term, we seem to have overcome the last wave of restructurings—faster than anticipated,” said Michael Henkin, co-head of restructuring at Jefferies & Co. “Things came back pretty quickly, and the capital markets have solved a lot of the concerns that were out there on corporate defaults.”
An economy that has stabilized—albeit tentatively—has helped many struggling companies stay alive. Another big factor has been low interest rates set by the U.S. Federal Reserve. The rates have made investors hungry for higher-yielding debt, which has spurred them to buy bonds of risky companies at a record pace. While business fundamentals or a double-dip recession could eventually fell these firms, for now they have ample access to capital.
“The rebound is breathtaking,” said David Keisman, a Moody’s senior vice president.
The access is concentrated in companies large enough to issue bonds to the public. Smaller businesses, which depend primarily on bank lending, are still having a harder time getting capital.
The change is also on display in a new Moody’s report that tracks companies most in danger of defaulting on their debts. Some 288 companies were on the list, formerly dubbed the Bottom Rung, in June 2009. The number is now 195.
The Moody’s list comprises companies with the worst credit profiles: those bearing a “probability of default” rating of “B3” or lower, with a negative outlook or on review for a possible downgrade. The companies on the current list, including the likes of Univision Communications Inc. and trucking company YRC Worldwide Inc., carry more than $250 billion of bank and bond debt. A representative for Univision said in a statement that the company is “in a position of financial strength” and that it has “proven [its] ability to successfully manage [its] balance sheet.” A representative for YRC declined to comment.
Moody’s only started compiling the list at the height of the credit crisis and acknowledges more time is needed to assess what constitutes a “normal” number of companies so deep in “junk” territory.
The white-hot junk-bond market has afforded many weaker firms—including those still deemed riskiest by Moody’s—opportunities to refinance debt obligations and delay major reckonings. Companies have sold more than $175 billion in junk bonds so far this year, according to Dealogic, shattering 2009’s record.
Overall, Moody’s said its list of riskiest firms “may be at or near a long-term mean.” Much of that stability is a result of fewer additions to the list as the economy remains “in muddle mode,” said Moody’s Mr. Keisman.
Many of these companies were the subject of bankruptcy fears over the past few years. But firms from across the economy managed to avoid painful restructurings and bounce back. Auto-parts supplier American Axle & Manufacturing Holdings Inc., United Airlines parent UAL Corp. and luxury retailer Neiman Marcus Group Inc. are among the varied names no longer grouped among the riskiest firms Moody’s rates.
Better earnings and easier refinancing terms have led to ratings upgrades, moving firms off the list. Some 27 companies left it in the third quarter, while 13 were added. Moody’s said it doesn’t see any signs the roster will grow in the near term, even in the face of sluggish economic growth that produced three bankruptcy filings this week, including by retailer Urban Brands Inc. and hospitality company Ultimate Escapes Inc.
Some have just survived the storm. United Airlines’ parent struggled amid skyrocketing fuel prices and a pullback from travelers during the depths of the recession. But it recently reported $273 million in second-quarter earnings. UAL is now poised to merge with Continental Airlines Inc. In August, Moody’s boosted the United Airlines parent’s rating to “B3,” noting the company remained on review for yet another upgrade amid the merger expectations.
Some companies have dropped off the Moody’s list because of defaults, such as Blockbuster Inc., the struggling movie-rental chain that has warned investors of possible bankruptcy. Others have been added to the list, including hotel operator Gaylord Entertainment Co. The owner of the Grand Ole Opry suffered from recent flooding in Nashville, Tenn. A Gaylord spokesman said the company’s outlook change reflected the shutdown of the Gaylord Opryland hotel during the recent flood, a “once-in-a-thousand-year event.” Gaylord plans to reopen the property in November, has sufficient liquidity to cover rebuilding costs and doesn’t have any pending issues with debt covenants, the spokesman added.
More broadly, Moody’s noted debt maturities over the next few years remain a “critical hurdle” for risky firms. Roughly $800 billion of risky debt matures over the next four years, raising the prospect more defaults could be in store should refinancing conditions worsen.
Of those moving off the list, American Axle represents one of the more pronounced corporate comebacks. Analysts and investors were almost certain American Axle would seek bankruptcy protection last summer, following in the footsteps of General Motors, its largest customer. GM successfully restructured, then paid American Axle $110 million that stemmed from costs and contracts related to the auto maker’s bankruptcy. GM also extended a $100 million loan, which American Axle says it has yet to tap.
In December, the supplier of axles and drive lines that connect a vehicle’s transmission and wheels raised more than $100 million in a stock sale. The same month, American Axle sold $425 million in bonds, using the proceeds to repay bank debt. The reduction in debt burdens means American Axle doesn’t face a “significant maturity” until 2013, said Michael Simonte, the supplier’s finance chief.
Meanwhile, American Axle closed and sold off plants and got further cost savings by negotiating a new contract with the United Auto Workers union.
American Axle is still a “junk”-rated company, and the domestic auto industry’s recovery remains nascent. The parts maker must diversify away from a heavy reliance on the sales of trucks and sport-utility vehicles amid shifts in consumer tastes.
American Axle’s stock trades at around $9, a far cry from the summer of 2009, when its price dropped below $2 and some investors thought the company didn’t stand a chance, said Mr. Simonte, the finance chief. “It’s really remarkable how different the business condition is for our company today than it was a year ago,” he said.