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ANALYSIS
March 2, 2009
Sagging Index no longer reflects what’s going on in the market, some say, Replacements? Google it, to start.
March 2, 2009
Downward price spiral will actually boost the cost of capital for most companies. CFOS, take note.
March 2, 2009
The latest bailout at AIG could be a preview of how the president will deal with Wall Street.
March 2, 2009
No corporate defaults. Big debt offerings. Percolating CP issuance. Things may be looking up in the capital markets.
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December 19, 2008 12:18 PM ET
Coming defaults on junk bonds are likely to be more severe than investors may be expecting, warned a report published yesterday in Distressed Debt Investor, a bi-weekly high-yield debt research service. The report, by Martin Fridson, noted that the number of defaults may be higher than, for example, Moody’s Investors Service expects based on the experience of previous recessions and the fact that shareholders may have less incentive to service interest payments than is expected. Mr. Fridson said he expected defaults among bonds that Moody’s rates Ba or lower to occur at an annual rate of at least 12%, rather than the 10% that Moody’s expects. Tribune Co.’s recent bankruptcy filing is an indication of why that may be the case, Mr. Fridson wrote. While the company faced an interest payment of only $70 million, it chose not to make it despite more than enough cash on hand to foot the bill. Mr. Fridson added that the filing should “jolt investors out of complacency” regarding the possibility of default by companies that face no immediate cash squeeze because they took advantage of highly favorable financing conditions to extend their maturities before the credit crunch materialized. Citing research findings that have been neglected in the current cycle, Mr. Fridson noted that default “has nothing to do with imminent cash shortfalls or covenant violations.” Instead, he noted, the phenomenon reflects the fact that when the expected value of future cash flows falls below the value of liabilities, “the rational equity holder ceases to have a motivation to continue servicing the debt.” He reminded readers of the relevance of a famous line by the oft-divorced actor Mickey Rooney, who said that paying alimony was like pumping gas into another man’s car. Mr. Fridson went on to write that Moody’s projection of a 10% default rate on high-yield bonds seems to be derived from the experience of the relatively mild 2001-2002 recession, whereas economists now expect the current recession to more closely resemble those of 1990-1991 and 1982-1983. In those deeper recessions, default rates were 19% and 9%, respectively (with the milder, more recent recession producing a higher rate because of heavier issuance). By comparison, default rates during the Great Depression peaked at 16% in December 1933, Mr. Fridson added. He also dismissed observations that the high default rate of the 1990-1991 era was exaggerated by politically motivated federal officials out to punish the leveraged buyout financier Drexel Burnham Lambert, saying that factor was less likely to have driven defaults than market conditions. In the same vein, he noted that observers who suggest that that cycle was decidedly different from the current one fail to see how LBO activity drove the run-up in the market in both periods. “High yield boosters who expect the rate to peak in single digits look decidedly optimistic,” Mr. Fridson concluded.
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