Second Quarter Sees Record Number of Corporate Defaults

Includes: F, GM
by: Tyler Durden

The second quarter of 2009 set a new record for the number of corporate defaults, with 82 non-financial events of default, consisting of 16 names in media and entertainment, 15 in autos and 15 in natural resources, according to a new report published by S&P. The total amount of defaulted debt was $254 billion, far larger than the $102 billion spread among 69 defaults in all of 2008.

Of the second-quarter defaults, the largest portion (about 42%) resulted from distressed exchanges, 28% from missed payments, and 27% from bankruptcies. Distressed exchanges occur when a borrower offers creditors securities or cash in exchange for their debt claim that are worth less than the nominal present value of their original claim.

S&P is still predicting a record amount of speculative-grade defaults over the next 12 months, with an expected peak around Q1 of 2010, hitting a total of 13.9% of issuers some time in mid-2010.

This reflects our expectation of continued weak economic conditions and tight credit markets, although we do expect the credit markets to continue to ease somewhat through year-end.

As Zero Hedge has discussed extensively in the past, the predominant category of default event has become distressed exchanges.

As previously mentioned, distressed exchanges continued to account for a significant number of corporate defaults during the quarter. The new securities will often have different coupon rates, changes to the maturity term, or a change in a sinking funds (i.e., cash redemption) schedule. We consider distressed exchanges to be tantamount to default.

Not surprisingly, the sector hit the hardest was autos after the massive GM and Chrysler defaults, whose impact has been materially mitigated via taxpayer cash filling the gap.

Several sectors saw the most significant number of defaults during the quarter: automotive, media and entertainment, gaming and leisure, and natural resources. Three of the defaulted issuers with large debt balances were automakers: Ford Motor Co. (about $46 billion in rated debt), General Motors Corp. (GM; about $21 billion), and Chrysler Corp. (about $9 billion). Media and entertainment and gaming and leisure combined accounted for 15 defaulted borrowers, including issuers with large rated debt balances such as Harrah's Entertainment Inc. ($25.6 billion) and R.H. Donnelly Corp. ($7.6 billion). Of the defaults mentioned, Ford and Harrah's were distressed exchanges, while Chrysler and GM filed for Chapter 11 bankruptcy protection.

And here is punchline: the impact of declining cash flows for the non TBTF is becoming increasingly acute, especially for leveraged companies that have a small chance of refinancing at anything even closely resembling preferential terms. Ironically, the artificially low Libor per the BBA is likely hindering secured debt transactions, which could be one source of refinancing as unsecured debt could potentially be rolled into the secured level at many companies which have the collateral and capacity to issue secured credit. Here is S&P's perspective:

Many companies continue to experience cash flow pressures and covenant compliance issues because of declining sales and earnings. Operating results and credit protection measures deteriorated for all of the defaulted companies, leading to liquidity problems. Many missed interest payments and were not able to obtain covenant waivers or alternative financing, and ultimately filed for Chapter 11. We rated these issuers in the low speculative-grade category ('B' or below). Standard & Poor's had rated most of these issuers at 'CCC+' or below prior to their defaults.

As the impacts from the weakness in the auto sector spreads into the supplier base and into its subsequent feeder channels, look for increasing weakness across whatever is left of the US industrial base, and, of course, continuing layoffs.