Corporate Debt: The Great Deleveraging

As the downturn drags on, companies become less willing and able to service their former levels of debt

By Andrew Watt From Standard & Poor's RatingsDirect

Corporations are deleveraging their balance sheets—whether by choice or because of circumstances. A number of obvious factors are behind this, one being investor sentiment in the capital markets. The capital markets are generally more receptive and have a more favorable view of issuers with solid credit profiles and sufficient liquidity to withstand and persevere through the economic downturn. For example, investment-grade (BBB- or above) bond issuance is robust because investors have more confidence about the ability of companies with stronger credit profiles to maintain acceptable credit quality in this recession.

While the debt markets have been accommodating to investment-grade issuers, they've largely turned away speculative-grade issuers. Many speculative-grade companies became overly burdened with debt when credit terms were abnormally lax and the cost of debt was extraordinarily low. In many cases, some form of financial restructuring has been necessary because of overleveraged capital structures arising from the cheap credit available in 2005-07.

For lower-rated speculative-grade issuers, the recessionary operating environment has intensified their troubles. So business plans premised on supportive economic conditions have been undermined by the combination of high debt leverage and deteriorating financial performance. More specifically, we currently rate about 200 U.S. entities in the CCC category or below, ratings that indicate a high degree of financial distress. An additional 200 or so nonfinancial U.S. companies have corporate credit ratings of B- and are therefore in a vulnerable credit situation. Such companies are now exercising financial discipline because the credit markets are reluctant to fund entities with such low credit profiles.

Massive Bankruptcies

A clear, and perhaps perverse, instance of this great unwinding of corporate leverage is the surge in bankruptcies. Through the first half of this year, 117 nonfinancial U.S. companies defaulted on more than $339 billion of debt, including companies involved in a distressed exchange or buyback of debt, as well as other selective defaults, according to Standard & Poor's Global Fixed Income Research. The staggering amount of defaulted debt in just the first half of 2009 is triple the defaulted debt for the whole of 2008. Massive bankruptcies such as General Motors and Chrysler (not rated) have been the primary causes of the surge in defaulted debt. In addition, the outright failure of other large companies, such as Nortel Networks (not rated), that were well regarded not so long ago is a contributing factor.

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