A Debt Deferred

Revitalized capital markets and forgiving lenders helped overleveraged companies fend off bankruptcy in 2009. Is this the year the bill comes due?

Is the credit crisis ancient history, or was 2009 merely a stay of execution? Joe Ragan, CFO of Boart Longyear, hopes that it’s the former. The Salt Lake City–based finance chief spent 80 nights in Sydney last year in an effort to recapitalize the Australia-listed drilling-services and mining-equipment company. Its revenue had fallen so low that analysts predicted a breach in debt covenants, and its stock traded at liquidation value. By November, Boart Longyear had deleveraged by more than 90%, but only by issuing a large amount of new equity, more than doubling the number of shares already outstanding.

Unfortunately, for many highly leveraged businesses the credit crisis is far from over. Although the default rate of bond-issuing corporations is projected to drop by half (to about 7% in 2010, according to Fitch Ratings), there is also evidence that many CFOs will have to renegotiate with creditors this year. They may not be as successful the second time around.

The credit default swap (CDS) market is pricing in expectation of more corporate defaults. The Baird CDS Index, an index of 36 CDS contracts for non-investment-grade debt, dropped throughout 2009 but remains six times its base level of January 31, 2006. “We’re not out of the woods,” says William Welnhofer, a managing director of investment banking at Robert W. Baird & Co.

One reason for pessimism is the prevalence of distressed-debt exchanges in 2009 as a “cure.” More than 100 issuers bought back or exchanged for equity billions of dollars of bonds at steep discounts, according to Standard & Poor’s, compared with only 70 issuers that filed for bankruptcy. But bond exchanges, which count as a default, don’t wipe the balance sheet as clean of debt as bankruptcy does, according to studies by Fitch Ratings.

Indeed, even after a debt exchange, companies like Freescale Semiconductor, McClatchy, and Harrah’s Entertainment are still rated CCC, says Mariarosa Verde, a managing director at Fitch Credit Market Research. CIT Group and Six Flags conducted distressed-debt exchanges in 2009, only to declare bankruptcy later on.

Additionally, about $163 billion of speculative-grade debt will need to be refinanced in 2010, with greater amounts maturing between 2011 and 2014. “A concern in 2010 is not only the risk of new defaults but also a heightened risk of serial defaults,” Verde says. “If growth proves weak, some of the debt-restructuring measures adopted over the past year may have been successful only in helping companies defer, rather than avoid, bankruptcy.”

Giving Ground

It may sound odd, given the tougher lending criteria of banks, but in some cases lenders are bending over backwards to keep borrowers in business.

Companies issued record amounts of junk bonds in the last three quarters of 2009.

For example, following a $538 million debt-exchange offer, lenders of YRC Worldwide agreed to defer nearly all interest and fees and let the trucking company access a revolver reserve. (YRC hasn’t posted a quarterly profit since 2006.) Similarly, creditors of Broder Bros., a distributor of corporate apparel, agreed to waive defaults relating to a delay of the company’s 2008 audited financial statements and nonpayment of monthly interest. (Broder has a shareholders’ deficit.) And at press time, Freescale Semiconductor was seeking permission from its banks to sell extra debt to repay its loans — despite already having more than $7 billion of high-yield bonds and loans on its books.

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