In August last year, Moody’s issued what was then considered a gloomy outlook for corporates in the US. The ratings agency said it expected the global default rate to reach to 6.3 per cent by the following August, and as high as 10 per cent by the end of 2009 “should the US sink into a protracted recession.”
In December, following the collapse of Lehman, Moody’s revised its estimates for junk-rated companies slightly higher, to 10.4 per cent by November 2009 – compared with 3.1 per cent in the same period in 2008. These levels, if reached – and FT Alphaville thinks they will be attained and surpassed – were last seen in the aftermath of the 2001 dotcom crash.
Consider the parlous state of (non-financial) corporates today, particularly in the US and the UK. The latter has already had a series of high-profile corporate failures, including (but certainly not limited to) XL Airways, Woolworths and Zavvi.
In North America, Circuit City’s descent into liquidation and the Chapter 11 filings of Nortel and LyondellBasell do not bode well for their industry peers.
S&P expects the US corporate default rate to reach all-time high of 13.9 per cent this year, a significant revision of its previous projection a 7.6 per cent base-case and the consequence of “a substantial worsening of the economy and the financial environment”.
Moreover:
The baseline projection of 13.9% would result in an unprecedented trough-to-peak increase of almost 13%, outstripping the rate of increase observed in any prior default-rate cycle since the start of our series in 1981.
The continued high stress level in the financial system–which has wrought changes unprecedented since the Great Depression–is expected to ripple through more broadly, materially affecting the number of defaults
The ripple effect of corporate defaults, Chapter 11 filings and liquidations must not be underestimated.
As Diane Vazza, S&P’s head of global fixed income research and the author of the S&P report referenced above explained in a radio interview:
[Defaults affect] the entire supply chain. And we saw that very clearly with the automotives. We saw that fan out to all the automotive suppliers. You know, it’s like an onion. And the layers of the onion are . . . you get larger and larger as it affects the entire supply chain.The Circuit City bankruptcy provides a compelling example of this, as the imminent closure of Circuit City’s 567 remaining retail outlets – on top of more than 150 that were shuttered in November – will have a pronounced effect on commercial real estate. Paul Kedrosky estimates these closures mean around 22m square feet of retail space is suddenly empty – in an already depressed retail environment. And, as Reuters rightly noted in a story this week, this will also put pressure on investors in CMBS and REITs:
The loss of the large tenant, whose stores typically run from 35,000 to 40,000 square feet, is likely to be felt by some publicly traded shopping center owners, such as Developers Diversified Realty Corp DDR.N, where Circuit City accounted for 1.7 percent of its annual base rent revenue, and Kimco Realty Corp KIM.N, where the chain accounted for 1.5 percent of its annual base revenue, according to Green Street Advisors analyst Nick Vetter.
Other landlords include Inland Western Real Estate Retail Trust, Simon Property Group Inc SPG.N, Vornado Realty Trust VNO.N, Weingarten Realty Investors WRI.N, First Capital Realty Inc (FCR.TO), Kite Realty Group Trust KRG.N and Arcadia Resources Inc (KAD.A), according to financial data firm SNL Financial.
About half the shopping centers where Circuit City is a major tenant have mortgages that have been pooled and manufactured into CMBS, with more than $4 billion left on the balance of the mortgages, according to Realpoint.
The numbers don’t look good. Circuit City accounts for more than 20 percent of the revenue rent on 176 of the properties.
Those properties contribute 38 percent of the total loan exposure. Without Circuit City, occupancy at 187 centers would fall to less than 80 percent, meaning it would hurt mortgage payments to bondholders, Realpoint said.
Corporate defaults also put pressure on already strained banks and other financial companies that can scarcely afford to be stiffed by one significant debtor after another. And then, of course, there are the job losses, which compound the woes facing consumers.
Nor is the developing world immune. Standard Chartered, for instance, believes “[c]orporate debt is going to be one of the biggest issues in emerging markets in the next two years,” according to this Bloomberg story.
The story also cites data compiled by Commerzbank AG that show “businesses across emerging markets have more than $218 billion of bonds and syndicated loans coming due in 2009″:
Russian companies need to repay $54 billion of debt, followed by Mexican issuers with $29 billion coming due and Brazilian firms with more than $24 billion. Currencies from all three nations have dropped more than 20 percent against the dollar in the past year, increasing the cost of servicing foreign-currency obligations.In Poland, for example, the defaults have already begun.
As CreditSights analyst Chris Taggert put it,
The market is faced with the prospect of a default cycle tantamount to the worst historical periods outside of the Great Depression
Fundamentals hurt, weak balance sheets maim, but liquidity kills.All that, and it’s still only January. Tin hats, chin strap level five at least.
Related links:
The Next Threat To The Financial System: Corporate Defaults – 24/7 Wall St