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Author: WendyBG Big gold star, 5000 posts Top Favorite Fools Top Recommended Fools Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35387  
Subject: Wave of bad corportate debts Date: 2/16/2009 1:11 PM
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I have discussed the dangers of "toxic waste" corporate debt on METAR for quite a while.

"High-yield" or junk bonds were used to finance many mergers and acquisitions in the 2003-2007 timeframe. Many of these bonds contained lender-unfriendly clauses called "PIK-toggle" and "covenant lite," which allowed companies to take on too much debt and to pay interest with more debt. Personally, I wouldn't touch these with a 10-foot pole.

During those years, the risk premium (over safe bonds, like Treasuries) was very low. Now the risk premiums are much higher, and the value of those bonds have plummeted.

These problems were already raising their ugly head in 2007, but the recession has raised the risk of default even higher.

http://www.nakedcapitalism.com/2007/09/standard-poors-corpor...


Thursday, September 20, 2007
Standard & Poor's: Corporate Defaults Set to Rise

...
The proportion of high-yield bonds that have been pretty junky, rated B-minus or below, has been high in recent years (see chart below). The most recent figure, for April 2007, was nearly 50%. The worst of all ratings (except for those issues that are already in default) is CCC; this is the rating for around 20% of junk bonds and more than 50% of debt issued by this year’s leveraged buy-outs. Historically, more than half of CCC bonds default within six years.

...
The bulk of new defaults is likely to be found among the hundreds of companies with weak financials that over the past few years took advantage of over-accommodating capital markets to load up their balance sheet with debt.

"These companies are highly reliant on financial market access to support operational cash needs, but the plentiful liquidity for high-yield borrowers is almost surely a thing of the past," S&P said.

The problem has been compounded by a steady rise in the proportion of US companies with a junk bond rating - a result of the boom in high-yield bond issuance over the past few years.

Companies rated "B", the most common junk bond category, or lower, by S&P now make up some 40 per cent of the US corporate universe outside the financial sector, up from 35 per cent a decade ago....
[end quote]

The above article was written just before the credit crunch began. At the present time, plentiful liquidity for weak businesses is very definitely a thing of the past.

Now to today's news:

http://online.wsj.com/article/SB123446235205578373.html


Wall Street Journal, FEBRUARY 13, 2009

Wave of Bad Debt Swamps Companies
By JEFFREY MCCRACKEN and VISHESH KUMAR

...<snip long list of bankrupt and defaulting companies>...

The U.S. is entering a period likely to feature the most corporate-debt defaults, by dollar amount, in history. By various estimates, U.S. companies are poised to default on $450 billion to $500 billion of corporate bonds and bank loans over the next two years.

In percentage terms, the projections from the three main credit-rating agencies for defaults on high-yield bonds approach levels last seen in 1933, according to an 87-year default-rate history compiled by Moody's Investors Service. The agencies expect default rates on these non-investment-grade bonds to triple to about 14% or higher this year, from around 4.5% last year....

Sometimes defaulting companies agree to give lenders ownership stakes in exchange for reducing or eliminating debt [instead of Chapter 11]. Such workouts can dilute or wipe out existing shareholders....

S&P estimates high-yield-bond default rates will hit 13.9% this year, but could go as high as 18.5% if the downturn is worse than expected. Moody's predicts a default rate around 16.4% this year....

At present, nearly two of every three nonfinancial companies have below-investment-grade ratings...

Because many corporate defaults turn into bankruptcies or other cutbacks, there is certain to be a spillover effect on U.S. unemployment, which is already at a 16-year high....

...the recovery rate [of defaulted debt] could fall to about 20 cents on the dollar, or lower, in this recession. ...
[end quote]

The huge amount and broad scope of corporate debt defaults has deep implications.

1. Stay away from bond funds, especially high-yield bond funds, unless you think the yields compensate you for risk to principal.

2. Stock investors should carefully evaluate the debt situation of their company.

3. Unemployment could rise, and credit could contract further -- macro impact.

4. Risk premiums will not drop for quite a while, if lenders have any common sense. This will raise the cost of corporate borrowing, and reduce profits.

Wendy (cross-posted on mETAR)
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