Post by jeffolie on Dec 18, 2007 14:25:20 GMT -6
Defaults to Quadruple as More Companies Cut to Junk (Update2)
By Fabio Alves
Dec. 18 (Bloomberg) -- U.S. corporate defaults probably will quadruple next year after the number of companies that lost their investment-grade credit ratings rose at the fastest pace since 2003.
Moody's Investors Service predicts companies will default on 4.7 percent of their bonds in 2008 as the economy slows, up from 1 percent this year. Jones Apparel Group Inc., the Bristol, Pennsylvania-based maker of Nine West shoes, mortgage lender Residential Capital LLC and 31 other companies with a combined $52 billion of debt were downgraded to junk by Moody's this year.
Corporate bonds returned 3.08 percent in 2007, less than the rate of inflation, as subprime-related losses drove buyers to the relative safety of government debt, according to data compiled by Merrill Lynch & Co. Standard & Poor's says companies cut to speculative grade fail to pay their debt on time at almost twice the rate of those that never were investment-grade.
``When the economy slows down, there's going to be more defaults and more companies going into junk land,'' said Mirko Mikelic, a senior bond fund manager at Grand Rapids, Michigan- based Fifth Third Asset Management, which oversees $13 billion in fixed-income assets.
This year is the worst for company debt compared with government securities since 2000, according to Merrill. Treasuries returned 7.79 percent, 4.71 percentage points more than corporate bonds, the data show.
Downgrades Accelerating
Downgrades are accelerating across America. Moody's reduced ratings on 389 corporate issues this quarter, compared with 150 upgrades, according to data compiled by Bloomberg. The gap was the biggest since the first quarter of 2003. Junk bonds are rated below Baa3 by Moody's and BBB- by S&P.
Another 447 borrowers in the U.S. are at risk of having their ratings reduced, according to an S&P statement today. Companies in the automotive industry lead the tally of those in danger of having their credit rankings lowered, S&P said.
Companies that lost their investment-grade rankings, known as fallen angels, included Natick, Massachusetts-based Boston Scientific Corp., the second-largest maker of heart devices, Belo Corp., the Dallas-based owner of the Dallas Morning News and 20 television stations, and Nuveen Investments Inc. of Chicago, which manages closed-end mutual funds.
Investors on average demand an extra 2.84 percentage points of yield to own corporate bonds rather than Treasuries, according to index data compiled by New York-based Merrill. The spread doubled since June, before losses from securities backed by subprime mortgages contaminated credit markets.
WorldCom, Adelphia
The last time so many companies were cut to junk was after WorldCom Inc. in Jackson, Mississippi, and Adelphia Communications Corp., then based in Coudersport, Pennsylvania, filed for bankruptcy in 2002.
The Merrill Lynch high-yield bond index has a par amount of $689 billion. The high-yield market totaled $882 billion in the third quarter, according to a Moody's estimate based on bonds outstanding.
Wider yield spreads may be a sign bondholders already account for the risk of more failures, said Jason Brady, a managing director at Thornburg Investment Management, which oversees $4 billion in fixed-income in Santa Fe, New Mexico.
``Investors are already anticipating the fact that there's going to be a lot more defaults, so I don't think spreads are going to widen out further the same way they did from July to here,'' Brady said.
Junk Debt
Defaults probably will remain below the 5 percent historical average, so bondholders will make money even if more borrowers miss payments next year, said Kenneth Hackel, head of fixed- income strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut.
Junk debt will gain about 5 percent in 2008, according to Peter Acciavatti, global head of high-yield strategy at JPMorgan Chase & Co. in New York, the top-ranked junk bond analyst in Institutional Investor magazine's annual poll.
Investors earned an average 8.85 percent a year on junk since 1987, Merrill data show.
U.S. companies are prepared for a weaker economy because debt exceeds earnings before interest, taxes, depreciation and amortization costs by 1.31 times on average, near the lowest since before 1991, said John Tierney, a credit strategist at Deutsche Bank AG in New York.
Target Interest Rate
The Federal Reserve reduced its target interest rate for overnight loans between banks by 1 percentage point to 4.25 percent in the past three months to help keep the U.S. from sinking into a recession. The rate will likely fall to 3.75 percent by the end of June, according to the median estimate of 66 economists and strategists surveyed by Bloomberg.
Credit ratings are falling as the U.S. economy's six-year expansion falters. Growth will slow to an annual pace of 1 percent this quarter, from 4.9 percent in the previous three months, according to the median estimate of 63 economists. The Fed forecasts expansion next year of 1.8 percent to 2.5 percent, down from a previous estimate of 2.5 percent to 2.75 percent.
Declining financial performance has overtaken debt-fueled leveraged buyouts as the top reason for a cut to junk, S&P data show. Acquisition-related activity accounted for 47 percent of fallen angel downgrades as of Dec. 5. Until October, 63 percent of companies lowered to speculative grade were because of LBOs.
Private-equity firms announced a record $582.6 billion of deals in the first half of 2007, Bloomberg data show. That fell to $171 billion in the past five months.
``The economy will be the prevalent factor for the rise in the number of fallen angels,'' said Sabur Moini, a portfolio manager in Los Angeles at Payden & Rygel, which oversees $50 billion of fixed-income assets. ``Financing is more difficult, so you can't put as much leverage in a company as before.''
House Prices Decline
House prices declined 4.5 percent in the three months through September from the same period a year earlier, the most since records began in 1988, according to a Nov. 27 report by S&P/Case-Shiller.
Homebuilders, including Miami-based Lennar Corp., Pulte Homes Inc. and D.R. Horton Inc., lost their investment-grade ratings in November. Lennar is the largest U.S. developer, followed by Bloomfield Hills, Michigan-based Pulte. D.R. Horton in Fort Worth, Texas, is the fourth-largest.
``With the economic slowdown, we will have a year of more ratings downgrades than upgrades, steeper default rates as well as more fallen angels,'' said John Lonski, the chief economist at New York-based Moody's. The chances of a recession are almost 50 percent, he said.
Residential Capital
Residential Capital, with $16.6 billion of debt, was the largest fallen angel in the U.S. this year. The Minneapolis-based company, known as ResCap, was downgraded to Ba1 by Moody's in August on concern about its ability to raise cash. The biggest closely held U.S. mortgage lender was downgraded a second time, to Ba3, after a $2.3 billion third-quarter loss.
Investors demand an extra 21 percentage points in yield to own ResCap's $2.5 billion of 6.375 percent notes due in 2010 rather than Treasuries of similar maturity. The spread was 11.1 percentage points when the debt was cut to junk, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
ResCap said in October that it would eliminate 3,000 jobs, a quarter of its workforce, and received almost $2 billion from its parent, GMAC LLC, through the first three quarters.
``We're not content with the current ratings and we're focused on addressing the challenges of the mortgage business and executing a turnaround plan,'' said Gina Proia, a spokeswoman for Detroit-based GMAC.
Jones Apparel
Jones Apparel was cut to speculative-grade this quarter after the company sold Barneys New York Inc. for $945 million to an affiliate of Dubai's Istithmar PJSC. Moody's lowered the ranking to Ba1, and S&P cited a ``weaker'' risk profile for cutting Jones's $750 million debt to BB+.
``We continue to have discussions with the rating agencies, focusing on our road map to return to investment grade,'' John McClain, Jones's chief financial officer, told analysts on an Oct. 31 conference call. The downgrade is having a ``minimal impact'' on financing costs, McClain said.
Punitive Spreads
Investors demand an extra 4.28 percentage points in yield to buy Jones Apparel's $250 million of 6.125 percent bonds due in 2034 rather than Treasuries, up from 2.14 percentage points on Jan. 24, Finra data show.
Fallen angels are punished more than other companies when their debt is downgraded.
The yield gap between borrowers rated BBB and BB is 1.89 percentage points, Merrill data shows. The gap is four times wider than the 0.47 percentage point difference between A and BBB debt and twice as big as the 1.06-percentage-point-spread between BB and B.
``On the scale of pain inflicted on investors as rating move in a more negative direction, fallen angels are near the top,'' said Fara Lupiano, an analyst at CreditSights Inc., an independent bond research firm in New York.
At least 20 companies are at risk of becoming fallen angels, according to S&P. Most are in industries that typically suffer as the economy slows, said Diane Vazza, head of global fixed-income research at S&P in New York.
Luxury Items
The list has three retailers, including Columbus, Ohio-based Limited Brands Inc., the owner of the Victoria's Secret chain, and IndyMac Bancorp Inc. of Pasadena, California, the second- largest U.S. independent mortgage lender.
Retailers of luxury items and non-essential products in danger of slipping to speculative grade, will be under added pressure to retain their ratings as consumer spending drops, Fifth Third's Mikelic said.
``People are going to eat first,'' he said.
Louisiana-Pacific Corp., the biggest U.S. maker of wood panels and boards, and Office Depot Inc. are ranked BBB- at S&P. Louisiana-Pacific, based in Nashville, Tennessee, has a ``negative'' outlook. Delray Beach, Florida-based Office Depot, the world's second-largest office-supplies retailer, is on review for a downgrade.
CSX Corp. Chief Executive Officer Michael Ward said he's determined to keep the Jacksonville, Florida-based railroad's rating, which was put in jeopardy after the company agreed to buy back $3 billion of stock to appease activist shareholders.
``It's important that railroads have access to capital markets in every condition, which is not possible when you're at junk bond status,'' Ward said in an interview last month.
www.bloomberg.com/apps/news?pid=20601009&sid=a5HtTFblJu_4&refer=bondheads
By Fabio Alves
Dec. 18 (Bloomberg) -- U.S. corporate defaults probably will quadruple next year after the number of companies that lost their investment-grade credit ratings rose at the fastest pace since 2003.
Moody's Investors Service predicts companies will default on 4.7 percent of their bonds in 2008 as the economy slows, up from 1 percent this year. Jones Apparel Group Inc., the Bristol, Pennsylvania-based maker of Nine West shoes, mortgage lender Residential Capital LLC and 31 other companies with a combined $52 billion of debt were downgraded to junk by Moody's this year.
Corporate bonds returned 3.08 percent in 2007, less than the rate of inflation, as subprime-related losses drove buyers to the relative safety of government debt, according to data compiled by Merrill Lynch & Co. Standard & Poor's says companies cut to speculative grade fail to pay their debt on time at almost twice the rate of those that never were investment-grade.
``When the economy slows down, there's going to be more defaults and more companies going into junk land,'' said Mirko Mikelic, a senior bond fund manager at Grand Rapids, Michigan- based Fifth Third Asset Management, which oversees $13 billion in fixed-income assets.
This year is the worst for company debt compared with government securities since 2000, according to Merrill. Treasuries returned 7.79 percent, 4.71 percentage points more than corporate bonds, the data show.
Downgrades Accelerating
Downgrades are accelerating across America. Moody's reduced ratings on 389 corporate issues this quarter, compared with 150 upgrades, according to data compiled by Bloomberg. The gap was the biggest since the first quarter of 2003. Junk bonds are rated below Baa3 by Moody's and BBB- by S&P.
Another 447 borrowers in the U.S. are at risk of having their ratings reduced, according to an S&P statement today. Companies in the automotive industry lead the tally of those in danger of having their credit rankings lowered, S&P said.
Companies that lost their investment-grade rankings, known as fallen angels, included Natick, Massachusetts-based Boston Scientific Corp., the second-largest maker of heart devices, Belo Corp., the Dallas-based owner of the Dallas Morning News and 20 television stations, and Nuveen Investments Inc. of Chicago, which manages closed-end mutual funds.
Investors on average demand an extra 2.84 percentage points of yield to own corporate bonds rather than Treasuries, according to index data compiled by New York-based Merrill. The spread doubled since June, before losses from securities backed by subprime mortgages contaminated credit markets.
WorldCom, Adelphia
The last time so many companies were cut to junk was after WorldCom Inc. in Jackson, Mississippi, and Adelphia Communications Corp., then based in Coudersport, Pennsylvania, filed for bankruptcy in 2002.
The Merrill Lynch high-yield bond index has a par amount of $689 billion. The high-yield market totaled $882 billion in the third quarter, according to a Moody's estimate based on bonds outstanding.
Wider yield spreads may be a sign bondholders already account for the risk of more failures, said Jason Brady, a managing director at Thornburg Investment Management, which oversees $4 billion in fixed-income in Santa Fe, New Mexico.
``Investors are already anticipating the fact that there's going to be a lot more defaults, so I don't think spreads are going to widen out further the same way they did from July to here,'' Brady said.
Junk Debt
Defaults probably will remain below the 5 percent historical average, so bondholders will make money even if more borrowers miss payments next year, said Kenneth Hackel, head of fixed- income strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut.
Junk debt will gain about 5 percent in 2008, according to Peter Acciavatti, global head of high-yield strategy at JPMorgan Chase & Co. in New York, the top-ranked junk bond analyst in Institutional Investor magazine's annual poll.
Investors earned an average 8.85 percent a year on junk since 1987, Merrill data show.
U.S. companies are prepared for a weaker economy because debt exceeds earnings before interest, taxes, depreciation and amortization costs by 1.31 times on average, near the lowest since before 1991, said John Tierney, a credit strategist at Deutsche Bank AG in New York.
Target Interest Rate
The Federal Reserve reduced its target interest rate for overnight loans between banks by 1 percentage point to 4.25 percent in the past three months to help keep the U.S. from sinking into a recession. The rate will likely fall to 3.75 percent by the end of June, according to the median estimate of 66 economists and strategists surveyed by Bloomberg.
Credit ratings are falling as the U.S. economy's six-year expansion falters. Growth will slow to an annual pace of 1 percent this quarter, from 4.9 percent in the previous three months, according to the median estimate of 63 economists. The Fed forecasts expansion next year of 1.8 percent to 2.5 percent, down from a previous estimate of 2.5 percent to 2.75 percent.
Declining financial performance has overtaken debt-fueled leveraged buyouts as the top reason for a cut to junk, S&P data show. Acquisition-related activity accounted for 47 percent of fallen angel downgrades as of Dec. 5. Until October, 63 percent of companies lowered to speculative grade were because of LBOs.
Private-equity firms announced a record $582.6 billion of deals in the first half of 2007, Bloomberg data show. That fell to $171 billion in the past five months.
``The economy will be the prevalent factor for the rise in the number of fallen angels,'' said Sabur Moini, a portfolio manager in Los Angeles at Payden & Rygel, which oversees $50 billion of fixed-income assets. ``Financing is more difficult, so you can't put as much leverage in a company as before.''
House Prices Decline
House prices declined 4.5 percent in the three months through September from the same period a year earlier, the most since records began in 1988, according to a Nov. 27 report by S&P/Case-Shiller.
Homebuilders, including Miami-based Lennar Corp., Pulte Homes Inc. and D.R. Horton Inc., lost their investment-grade ratings in November. Lennar is the largest U.S. developer, followed by Bloomfield Hills, Michigan-based Pulte. D.R. Horton in Fort Worth, Texas, is the fourth-largest.
``With the economic slowdown, we will have a year of more ratings downgrades than upgrades, steeper default rates as well as more fallen angels,'' said John Lonski, the chief economist at New York-based Moody's. The chances of a recession are almost 50 percent, he said.
Residential Capital
Residential Capital, with $16.6 billion of debt, was the largest fallen angel in the U.S. this year. The Minneapolis-based company, known as ResCap, was downgraded to Ba1 by Moody's in August on concern about its ability to raise cash. The biggest closely held U.S. mortgage lender was downgraded a second time, to Ba3, after a $2.3 billion third-quarter loss.
Investors demand an extra 21 percentage points in yield to own ResCap's $2.5 billion of 6.375 percent notes due in 2010 rather than Treasuries of similar maturity. The spread was 11.1 percentage points when the debt was cut to junk, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
ResCap said in October that it would eliminate 3,000 jobs, a quarter of its workforce, and received almost $2 billion from its parent, GMAC LLC, through the first three quarters.
``We're not content with the current ratings and we're focused on addressing the challenges of the mortgage business and executing a turnaround plan,'' said Gina Proia, a spokeswoman for Detroit-based GMAC.
Jones Apparel
Jones Apparel was cut to speculative-grade this quarter after the company sold Barneys New York Inc. for $945 million to an affiliate of Dubai's Istithmar PJSC. Moody's lowered the ranking to Ba1, and S&P cited a ``weaker'' risk profile for cutting Jones's $750 million debt to BB+.
``We continue to have discussions with the rating agencies, focusing on our road map to return to investment grade,'' John McClain, Jones's chief financial officer, told analysts on an Oct. 31 conference call. The downgrade is having a ``minimal impact'' on financing costs, McClain said.
Punitive Spreads
Investors demand an extra 4.28 percentage points in yield to buy Jones Apparel's $250 million of 6.125 percent bonds due in 2034 rather than Treasuries, up from 2.14 percentage points on Jan. 24, Finra data show.
Fallen angels are punished more than other companies when their debt is downgraded.
The yield gap between borrowers rated BBB and BB is 1.89 percentage points, Merrill data shows. The gap is four times wider than the 0.47 percentage point difference between A and BBB debt and twice as big as the 1.06-percentage-point-spread between BB and B.
``On the scale of pain inflicted on investors as rating move in a more negative direction, fallen angels are near the top,'' said Fara Lupiano, an analyst at CreditSights Inc., an independent bond research firm in New York.
At least 20 companies are at risk of becoming fallen angels, according to S&P. Most are in industries that typically suffer as the economy slows, said Diane Vazza, head of global fixed-income research at S&P in New York.
Luxury Items
The list has three retailers, including Columbus, Ohio-based Limited Brands Inc., the owner of the Victoria's Secret chain, and IndyMac Bancorp Inc. of Pasadena, California, the second- largest U.S. independent mortgage lender.
Retailers of luxury items and non-essential products in danger of slipping to speculative grade, will be under added pressure to retain their ratings as consumer spending drops, Fifth Third's Mikelic said.
``People are going to eat first,'' he said.
Louisiana-Pacific Corp., the biggest U.S. maker of wood panels and boards, and Office Depot Inc. are ranked BBB- at S&P. Louisiana-Pacific, based in Nashville, Tennessee, has a ``negative'' outlook. Delray Beach, Florida-based Office Depot, the world's second-largest office-supplies retailer, is on review for a downgrade.
CSX Corp. Chief Executive Officer Michael Ward said he's determined to keep the Jacksonville, Florida-based railroad's rating, which was put in jeopardy after the company agreed to buy back $3 billion of stock to appease activist shareholders.
``It's important that railroads have access to capital markets in every condition, which is not possible when you're at junk bond status,'' Ward said in an interview last month.
www.bloomberg.com/apps/news?pid=20601009&sid=a5HtTFblJu_4&refer=bondheads