Sunday, February 22, 2009

Expanded Death Watch List: Over $185 Billion In Corporate Defaults Upcoming

Recently Moody's has been trying hard to atone for its near terminal dropping the ball in misguided ratings over the past decade. One of the byproducts of an internal reevaluation of how it does business is its Speculative Grade Liquidity (SGL) rating system, which supplements the old letter-based risk system, that has for decades split debt-laden companies into Investment Grade and Junk, with assorted gradations.

A brief run down on Moody's SGL rating system:

Moody's assigns SGL ratings to 512 issuers covering about $1.16 trillion of rated debt. The company estimates that SGL ratings cover about one-third of Moody's-rated speculative-grade issuers in the U.S. and Canada, about 62% of the rated debt. This differential is due primarily to Moody's practice of assigning SGL ratings only to companies with publicly available financial statements, which typically are larger issuers of debt.

To arrive at an overall SGL rating, Moody's analyzes four components and assigns a score to each one: cash flow and internal sources of cash; liquidity availability and external sources of cash; covenants; and alternative sources of liquidity (so-called back-door financing). The individual assessment of the four components may be different than the overall SGL rating.

The outcome of the framework is nevertheless an overall SGL rating on a scale of 1 to 4 that is comparable across the rated universe. The definitions are as follows:

  • SGL-1: Issuers rated SGL-1 possess very good liquidity. They are most likely to have the capacity to meet their obligations over the coming 12 months through internal resources without relying on external sources of committed

  • SGL-2: Issuers rated SGL-2 possess good liquidity. They are likely to meet their obligations over the coming 12 months through internal resources but may rely on external sources of committed financing. The issuer's ability to access committed financing is highly likely based on Moody’s evaluation of near-term covenant compliance.

  • SGL-3: Issuers rated SGL-3 possess adequate liquidity. They are expected to rely on external sources of committed financing. Based on Moody's evaluation of near-term covenant compliance there is only a modest cushion, and the issuer may require covenant relief in order to maintain orderly access to funding lines.
  • SGL-4: Issuers rated SGL-4 possess weak liquidity. They rely on external sources of financing and the availability of that financing is in Moody's opinion highly uncertain.
If a company is in SGL 4, the likelihood it will go from operating to bankrupt without passing go is virtually a certainty, especially in the current credit climate. The chart below demonstrates the rapid increase in the absolute number of SGL 4-rated companies as well as their portion of all SGL issuers.

What is scary, is that the total rated debt associated with SGL-4 companies is roughly $185 billion dollars. While it is an exaggeration that all of this debt will be completely wiped out, as the SGL 4 rating applies mostly to the lowest tranches of the debt, it is a near certainty that these riskiest tranches will default soon, leading to a forced reorganization of the entire associated capital structure.

One interesting corollary is that bankruptcy companies and lawyers, which tend to charge on average about 3.5% of total reorganized liabilities as a company progresses to a successful emergence out of Chapter 11, will soon pocket over $6 billion dollars assuming the entire $185 corporate tranche defaults. As bulge bracket banks sniff everywhere for a source of revenue, it is only a matter of time before the Goldmans and the Morgan Stanleys of the world acquire all the boutique restructuring firms such as Lazard, Evercore and Alvarez & Marsal.

The 92 SGL-4 currently rated companies are presented in the table below:

SGL - Free Legal Forms Sphere: Related Content
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