Moody’s Investors Service is warning that the tight credit markets and the suffering economy are producing a chemistry that dangerously increases debt refunding risk.
In its latest report report, Moody’s calculates that roughly $300 billion of investment-grade nonfinancial corporate bonds are scheduled to mature over the next three years. This includes $99 billion due in 2009, $83 billion due in 2010, and $117 billion due in 2011. In addition, $190 billion of U.S. corporate speculative grade bank and bond obligations will mature during the same time period. “Investment-grade companies have comparatively strong credit profiles, with more than half of the bonds maturing over the next three years rated single-A or higher,” says Kevin Cassidy, vice president and senior credit officer at Moody’s. “Still, the overall deterioration of ratings over the last year increases the refinancing risk,” it says, noting that the study of 330 investment-grade nonfinancial corporate issues “indicates that credit ratings have migrated downward during the last year.”
While the majority of maturing investment-grade bonds are relatively highly rated with more than half of the bonds maturing over the next three years rated single-A or higher, roughly $100 billion of the $300 billion maturing over the next three years is rated Baa2 or Baa3, the lowest investment-grade ratings. What’s more, 28 percent of the $10 billion of Baa3 rated bonds maturing in 2009 have a negative outlook or are under review for possible downgrade, the rating agency points out.
Moody’s warns that the broad financial crisis is elevating the refunding risk for most companies. “Maintaining a strong liquidity profile is critical as it will likely be costly to refinance upcoming maturities in 2009 due to expected continued weak economic conditions,” according to the ratings service.
It points out that as the global recession deepens, profitability and operating cash flow are deteriorating even for many investment-grade companies, and this may result in an increase in covenant violations. Indeed, Moody’s notes that a recent liquidity study found that 9 percent of investment-grade issuers are subject to either tight or restrictive covenants, defined as having less than 20 percent headroom under required covenant levels. “However, in contrast with the trend we are seeing for many speculative-grade issuers, we believe that the majority of investment-grade companies should be able to amend their credit facilities, although the cost may be substantial,” Moody’s adds.
In fact, the company stresses that 73 percent of the investment-grade bonds maturing over the next three years have a stable outlook while just 22 percent have a negative outlook or are under review for possible downgrade and 5 percent have a positive outlook. But even so, the cost of funding has escalated, even for the strongest investment grade companies, due to the global credit crisis. Investors have become extremely risk averse, underscored by very high spreads.
Among investment-grade bonds, Baa3-rated bonds were especially hurt by the credit market collapse. The spreads between a seven-year Treasury and the median Baa3 yield rose to a high of 796 basis points in December 2008 while the spread between a seven-year Treasury and the median Baa1 yield rose to 587 basis points. As a result, the difference in spreads between Baa3-rated bonds and Baa1-rated bonds was “an astounding” 210 basis points versus the historical average of 48 basis points.
Even bonds with the highest investment-grade rating, Aaa, have seen a substantial increase in spreads, with the spread between a seven-year Treasury and the median Aaa yield rising to a high of 253 basis points in November 2008, compared with an historical average of 80 points, according to Moody’s.
During the latter half of 2008, the spread between the three-month Libor rate and three-month T-bill, known as the TED spread, widened significantly. The spread peaked at 458 basis points in October 2008 shortly after Lehman filed for bankruptcy, according to Moody’s. However, by the end of January 2009, the TED spread had narrowed to more normal levels.
One big silver lining: Investors apparently have a strong appetite for non-financial investment-grade debt if they are well compensated. Moody’s points to the more than 150 percent increase in investment-grade non-financial corporate bond issuance during the first two months of 2009 versus the same period in 2008.
However, investment-grade debt markets are expected to recover before the speculative-grade credit markets given the flight to quality as well as low returns on Treasury securities, Moody’s says.