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Top News September 29, 2008, 12:00AM EST

Credit Crunch on Main Street

Defaults on corporate loans have jumped, lenders to McDonald's franchisees are strapped, and big names like GM are facing liquidity problems

The ripple effects of the week that shook Wall Street are now being painfully absorbed by nonfinancial companies across the nation, from carmakers to casinos. "Tightening financial conditions have expanded to reach nearly all sectors," says Diane Vazza, managing director of global fixed income research at Standard & Poor's, which, like BusinessWeek, is owned by The McGraw-Hill Companies (MHP). "Screaming headlines about the financial sector might give some the misleading impression that nonfinancials are mercifully out of the line of fire. Nothing could be further from the truth. The heat will eventually spread."

A growing number of companies are already feeling the heat. As of Sept. 9, 57 companies had defaulted on $45.3 billion of debt for the year, according to S&P RatingsDirect, up from 22 companies defaulting in all of 2007. (While not a bankruptcy, a default sets off clear alarm bells about a company's fiscal health.) Of the 57, 45 are outside the financial industry. And more defaults are likely on the way: Roughly 70% of nonfinancial companies carry a noninvestment or junk credit rating. S&P projects that the three-year cumulative default rate between 2008 and 2010 among nonfinancial firms with poor credit will rise to 23.2%, the worst on record since 1981.

Discerning which firms will cave first is difficult, but S&P has identified 162 "weakest links," or companies in danger of defaulting over the next 12 months. It is the seventh straight month that the roster of credit-unworthy firms has grown. On that list are high-profile names such as United Airlines parent UAL, General Motors, Tribune, Six Flags (SIX), and Trump Entertainment Resorts.

The cash crunch has hit U.S. automakers and airlines particularly hard. General Motors (GM), for one, announced on Sept. 19 that it was drawing down the remaining $3.5 billion of its $4.5 billion credit facility. Goldman Sachs (GS) analyst Patrick Archambault said GM might need to raise as much as $8 billion to cover monthly operating expenses of up to $14 billion. UAL (UAUA), meanwhile, is doing everything short of roaming through its cabins to look for loose change. The Chicago-based carrier just tightened its air miles credit-card deal with JPMorgan Chase (JPM) to infuse about $1 billion into the business, and it's trying to unload old 737 aircraft. "Cash is king," said United Chief Financial Officer Kathryn Mikells at an industry conference on Sept. 18. "In this unprecedented environment…the appropriate level of liquidity is even more critical."

Even the most iconic Main Street brands are not immune. Franchisees of McDonald's (MCD) were told Sept. 19 that Bank of America (BAC) could not provide any new loans to pay for the equipment and remodeling needed for the rollout of new coffee bars. "As of now, [Bank of America] is dependent on repayments to get additional funding capacity," said an internal memo obtained by BusinessWeek. "The bills are coming due, so the franchisees are turning to the banks," says Richard Adams, a consultant who works with 300 McDonald's franchisees. "But the banks are having their own problems."

McDonald's spokesman Walt Riker did not deny the Bank of America squeeze but insists that other banks are still willing to lend. "There are no credit issues at McDonald's," says Riker. Bank of America spokesman Larry DeRita, meanwhile, disputed the memo, denying any credit freeze. "We are not naive about the current lending environment and realize lending to franchisees will be more difficult," wrote Morgan Stanley (MS) restaurant analyst John Shanley in a note to investors.

Liquidity Challenges

There's no debate that gaming companies are taking it on the chin as consumers cut back on discretionary spending. Mohegan Sun and Boyd Gaming (BYD) have suspended expansion projects, while Pinnacle Entertainment (PNK) abandoned a planned acquisition bid. "Growth is stymied," says Wachovia (WB) analyst Dennis M. Farrell Jr. Trump Entertainment's future, Farrell says, is riding on a planned $316 million sale of Atlantic City's Trump Marina. Coastal Development Chairman Richard Fields says he has secured financing to buy it, but details are still sketchy. Even if the deal closes as planned, Trump's leverage ratio is still much higher than its peers, so all this does is "buy Trump some time," Farrell notes. A Trump spokesperson did not return calls for comment.

Companies are understandably reluctant to talk about cash woes, but their SEC filings speak volumes. "The company is highly leveraged," read the latest quarterly report filed by S&P "weakest link" member Merisant, maker of the artificial sweetener Equal. Debt payments could severely crimp innovation and marketing going forward, the company warned. (A spokeswoman declined to comment.) Even some technology firms, which are generally less leveraged than other sectors, are being swept up into the vortex. Semiconductor-industry supplier MKS Instruments (MKSI), facing a sharp slowdown in demand, took the unusual step of slashing executives' salaries to preserve cash. Merrill Lynch (MER) semiconductor analyst Brett Hodess has chopped his forecast of industry capital expenditure spending from 9% growth to a 6% decline, in part due to growing credit problems for some chipmakers.

Six Flags is another liquidity-challenged player. The theme park operator chose not to pay a dividend for the last two quarters, and its $3.1 billion of debt is rated CCC+, or junk status, by S&P. (The company declined to comment.) Such a rating, according to historical averages, means the odds of a default within one year are 1 in 4. If that happens, Six Flags looks likely to have plenty of company on the ride down.

Boyle is deputy Corporations editor for BusinessWeek.

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