The Wall Street Journal-20080206--Anyone for Some Used Corporate Debt--- A Year of Reckoning- Junk-Bond Defaults Are Seen to Multiply

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'Anyone for Some Used Corporate Debt?'; A Year of Reckoning: Junk-Bond Defaults Are Seen to Multiply

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The credit markets have for years proved a financial sanctuary to struggling companies in distressed industries like retailing, trucking and home building. But the easy money has gotten much harder to find.

The likely result, says the New York University professor who wrote the book on corporate bankruptcies, is a big jump in companies unable to pay their borrowing costs, which often can lead to job cuts and shuttered plants and offices.

In a closely watched report to be released today, finance professor Edward Altman projects that high-yield, or "junk," bonds will default by a rate of 4.64% this year. That would be the highest rate since 2003 and a nine-fold increase from the 0.51% rate in 2007, which was the lowest rate since 1981. High-yield debt is typically used by lower credit-quality companies to fund operations and acquisitions.

Mr. Altman, whose so-called Altman-Z score is the market standard for predicting bankruptcy, sees as much as $53 billion in high-yield debt defaulting in 2008, up from $5.5 billion in 2007. Mr. Altman's study takes into account a company's original credit rating when it received its financing, historic default rates, the size of debts outstanding, and other factors.

Already in January, Mr. Altman estimated defaults hit $3.2 billion, about 60% of the total for all of 2007. Among the defaults last month were companies like commercial printer Quebecor World Inc., carpet and fabric maker Propex Inc. and the Buffets Inc. restaurant chain. Other large companies missed payments, but were able to pay later or had a forbearance agreement in place.

New high-yield issues totaled a near-record of $141 billion in 2007, but almost $100 billion of that was in the first six months of the year before the credit market slowdown took fuller hold. In a recent Federal Reserve survey of senior bank-loan officers, one-third of U.S. banks and two-thirds of foreign banks said they had tightened lending on commercial and industrial loans. Half the banks said they widened the spread between their cost of funds and what they charge corporate borrowers.

Besides the tight credit market, bond defaults could also be driven up by the large amount of high-yield debt coming due. As companies look to roll over this debt, they will either have to pay higher interest rates or will be shut out entirely by lenders. Mr. Altman estimates about $160 billion in leveraged loans and about $30 billion in high-yield bonds will come due this year, a similar amount in 2009, followed by even more between 2010 and 2013.

Yesterday, the parent of moving-truck company Allied Van Lines filed for bankruptcy protection, making it the second large loan default in February and the third in a week. Earlier, home builder Tousa Inc. and auto-supplier Plastech Engineered Products Inc. filed for bankruptcy protection.

Allied's parent Sirva Inc. has struggled to make interest payments that rose following previous amendments to its credit agreement. In 2004, J.P. Morgan Chase & Co. launched a $490 million term loan for Sirva with lower interest payments, replacing an earlier loan. But in the most recent amendment this month, Sirva lenders waived covenant conditions that they expected to be tripped in June, as well as an interest payment that was paid six days late on Jan. 10.

Sirva's management has been in talks with lenders about restructuring and last week announced an 11th amendment to its credit agreement. Many corporate lenders are pushing for stricter terms than had been the case in previous years.

Mr. Altman's predicted default rate of 4.64% would exceed the historic average high-yield default rate since 1971 of 3.86%. The rate hasn't topped 4% since 2003. He predicts another jump in 2009 to 5%.

Various rating firms like Standard & Poor's Rating Service, Moody's Investor Services and Fitch Ratings have also predicted far higher defaults rates for 2008. Moody's, for example, predicted a jump to about 4.8%.

Mr. Altman's analysis doesn't take into account unemployment rate, gross domestic product growth or any other assumptions about the economy. Mr. Altman said "if there is a significant recession in 2008, then my default forecast and those of others will be too low."

Mr. Altman and others in the turnaround and bankruptcy fields have incorrectly predicted an upswing in defaults and corporate bankruptcies for the past two years, as an aggressive lending market allowed companies to sidestep their financial and operational problems. A year ago Mr. Altman predicted a default rate of 2.5% for 2007.

"Mea culpa. I was wrong. A lot of us were. The liquidity out there did that. There was a fair amount of rescue financing that went to companies that normally would have defaulted." he said.

Restructuring experts say the credit crunch could mean distressed industries like retail, restaurant chains and consumer products could this year start to mirror long-struggling areas like the U.S. auto- supply business. That industry has been besieged since 2005 by plant closures, massive layoffs and bankruptcies from smaller firms like Plastech to the country's largest supplier, Delphi Corp.

"The tight credit market will push a lot of companies, especially the underperformers in their industries, into restructuring mode where they are looking at closures and asset sales, layoffs," said Holly Felder Etlin, managing director at the business turnaround and consulting firm AlixPartners.

Ms. Etlin and others say the credit crunch will not only increase defaults and corporate bankruptcies, but it may also mean that bankrupt companies will have to liquidate because they or an interested purchaser can't get funding to continue operations or finance an acquisition.

Exotic loans and financing techniques such as "covenant-lite loans and second-lien loans . . . all that did was delay the day of reckoning for companies that will still hit the wall," said Barry Ridings, vice chairman of investment banking at Lazard Ltd.

(See related article: "Credit Markets: Why Leveraged Loans That Financed Buyouts Are Causing Bottleneck" -- WSJ Feb. 6, 2008)