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When will companies start going bust?

When will companies start going bust?
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First Published: Thu, Jan 10 2008. 12 02 AM IST
Updated: Thu, Jan 10 2008. 12 02 AM IST
In the end, it was US subprime mortgages that triggered the credit crunch. Earlier warnings about over-leveraged buyout targets and other heavily indebted companies proved wide of the mark. But corporate bankruptcies could still be the next instalment in the credit saga.
The default rate for junk-rated companies ended 2007 at a 26-year low just below 1%, according to Moody’s. The rating firm thinks that could rocket to nearly 5% this year. Even that would only take it to somewhere around the long-term average. Moody’s has a much higher pessimistic forecast running into double digits.
Investors are worried too. Risk premiums on high-yield and even investment grade-rated corporate debt have started the year spiking to new multi-year highs, suggesting rising concern about coming defaults.
One issue is the economy, especially in the US. Plenty of leveraged buyout financings, for instance, assume target companies will “grow into” debt loads that are a stretch to begin with. If growth ends up being anaemic, that may not happen. It doesn’t take a recession, either, as Martin Fridson notes in his Leverage World publication. Historically, the tipping point for a spike in US defaults is roughly 2% economic growth. Less than that—as many economists expect this year—and highly-leveraged companies run into trouble.
Then there are the credit markets. These have flipped from ultra easy until mid-2007 to very tough now. While some indebted companies get squeezed because they can’t pay interest, others run into big trouble only when they have to repay debt and borrow anew. Refinancing the most aggressive deals of 2006 and 2007 wouldn’t be possible now.
Yet, another factor is companies’ need to refinance. Many borrowers took advantage of the last couple of years of easy credit to refinance, and peak defaults tend to lag the issuance of debt by several years. Companies with until recently fashionable “covenant lite” debt, which lacks traditional early warning triggers, might be able to delay any reckoning a bit further still.
These effects might just keep a lid on defaults in 2008—but that would only defer the problem.
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First Published: Thu, Jan 10 2008. 12 02 AM IST