Where Credit Is Due

A new study of the largest issuers of corporate debt shows that recent gains in creditworthiness are more fragile than you think.

Consider Nextel. Like other telecom companies, it faced a sharp loss of investor confidence after the Internet bubble burst. And that’s evident in its EDF Credit Measure, which has more than doubled during the past three years, from 0.81 percent to 1.82 percent, despite a 6 percent decrease in asset volatility, according to the MKMV study. What’s driven the rise in EDF? A soaring increase in market leverage, a measure based on both the market value of a company’s assets and on what MKMV calls its “default point,” the point below which a company’s asset value must fall before MKMV’s historical database suggests it’s likely to default on its debt. In fact, while Nextel’s stock price fell to as little as $2 a share (against $20 today), its liabilities were growing, and as a consequence MKMV says Nextel’s default point peaked in 2001.

Since then, however, the company has taken a sharp turn in its capital structure, paying down some $5 billion in debt. Meanwhile, Nextel’s market cap has grown from $7.5 billion to $19.5 billion. All this has reduced its default point some 16 percent during the past year and contributed to its overall decline in market leverage of 49 percent. As a result, Nextel’s EDF has shown the most dramatic decrease of all 100 issuers during the past year, falling some 88 percent from more than 14 percent at the end of the second year of the study. “We spent a lot of time figuring it out,” says Saleh, who left his position as CFO of Walt Disney International to become CFO of Nextel in September 2001.

Verizon, in contrast, has had an easier time. The MKMV study finds that the telco’s EDF fell by 26 percent during the past three years, from 0.25 percent to 0.18 percent. But like Nextel’s, most of Verizon’s improvement has come during the past year, when this measure of default probability plummeted by 72 percent from a three-year peak of 0.80 percent in 2002. Also like Nextel, Verizon has been busy paying down debt. Net debt (total liabilities minus cash and cash equivalents) has been reduced by some $15 billion, from $63.4 billion at the end of 2001 to $48.1 billion at the end of second-quarter 2003. Most of that reduction reflects debt repayment from cash generated by reduced capital expenditures; sales of nonstrategic assets, including stakes in international subsidiaries; and productivity gains and other operational efficiencies.

While Verizon CFO Doreen Toben, who was appointed to the position in April 2002, says that the company “never had a liquidity issue” and has had “no access-to-capital problems at all,” she says pressure from the rating agencies in the wake of the meltdowns of Enron and WorldCom made it impossible for Verizon to avoid efforts to improve its balance sheet. The pressure has since eased, but Toben says the agencies “are still very nervous”—and not just about the telecom industry.

Similarly, Xerox’s EDF has fallen some 8 percent during the past three years, from 2.9 percent to 2.7 percent, but not before soaring to more than 15 percent at one point. The 75 percent decline in its EDF during the past 12 months largely reflects a $3.6 billion recapitalization last June. The recap included offerings of common stock, convertible preferred stock, and 7 and 10-year senior unsecured notes, as well as a new $1 billion credit facility. Xerox used the proceeds from the offering and the credit facility, as well as a portion of its current cash balance, to terminate $3.1 billion in outstanding obligations under its existing bank facility.


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