Crisis ahead in corporate debt?
Since 1925, the Grand Ole Opry has featured the music of countless country and bluegrass stars, from Bill Monroe to Dolly Parton.
As Ryman Hospitality Properties built a hospitality and entertainment empire around the original Nashville radio show, the parent company’s debt grew to more than $2.5 billion, but its chairman insisted that its balance sheet was “really strong.”
That held through the first week of March, when Ryman’s buildings escaped the tornado that hit Nashville. But another storm has since ripped through corporate debt markets. As coronavirus fears have consumed investors and wrecked the stock market, warnings over the potential of a rising debt load to push companies toward collapse are beginning to be tested.
After Ryman’s hotel customers canceled 77,000 room nights last week, at a potential $40-million cost to revenue, Standard & Poor’s placed its credit rating on watch for a potential downgrade.
The rating company’s response shows how a public health crisis is prompting a sudden reassessment of corporate credit risk, raising doubts about borrowers that had long been seen as stable.
That is changing how markets view sectors from cruise lines to retailers, forcing companies as large as Boeing and United Airlines to review their borrowings, and posing the risk of financial institutions being saddled with problem loans.
As Colin Reed, Ryman’s chairman, said last week: “We’ve had lots of experience in this type of thing, but this is a little weird.”
Companies have gorged on cheap debt for a decade, sending the global outstanding stock of nonfinancial corporate bonds to an all-time high of $13.5 trillion by the end of last year, according to the Organization for Economic Co-operation and Development, or double where it stood in December 2008 in real terms.
Borrowing costs had tumbled after central banks lowered interest rates to jolt their economies following the 2008 financial crisis. Investors, starved of yield from safer government bonds, saw lending to riskier companies as a way to juice returns.
Ruchir Sharma, chief global strategist at Morgan Stanley Investment Management, estimates that 1 in 6 U.S. companies does not have enough cash flow to cover interest payments on its debt. Such “zombie” borrowers could keep putting off the crunch as long as debt markets kept letting them refinance.
But now a reckoning is coming.
The consequences showed up most vividly last week in the oil and gas sector as a price war between Riyadh and Moscow compounded the market’s coronavirus concerns, plunging almost $110 billion of energy company bonds into distressed territory.
But the risks extend far beyond oil and gas. As Paloma San Valentin, managing director for the Americas at Moody’s, put it this week, there is now a “growing risk to corporate credit quality around the world.” The phones have started ringing at restructuring groups as directors and investors seek advice on how to navigate the uncertainty.
Rating agencies, still smarting from their reputation for moving slowly in the last crisis, are already sounding the alarm on companies that are most exposed to travel cancellations, disrupted supply chains and consumers’ deferred discretionary spending.
Moody’s has lowered its sales forecast for the auto industry and cut its outlook for the airline, lodging and cruise industries to negative. The cinema operator National Amusements joined cruise ship companies such as Carnival and Royal Caribbean on S&P’s “watch negative” list.
Bonds from car-rental company Hertz have been smashed, with yields on its longer-dated bonds hitting 10%. Cinema chain AMC saw a $628-million bond that was trading close to face value at the start of the year fall as low as 84 cents on the dollar Wednesday.
Meanwhile, carmakers, electronics groups and chemical companies all remain vulnerable because of supply chain interruptions.
The tally of defaults that preceded the market’s coronavirus shudder provides pointers to where the exposure may be most acute.
Eight of this year’s 20 large defaults have come from the consumer sector,
S&P found, including retailer Pier 1 Imports. A bankruptcy filing from McClatchy extended the sorry record of advertising-dependent local newspaper owners, and while there have been only two oil and gas defaults so far this year, the rating agency expects that number to rise. At 282 companies in December, S&P’s “weakest links” list of lowrated junk bonds on which it has a negative outlook was at its longest since the crisis era of July 2009.
Such lists fail to capture how many smaller companies are at risk of falling into financial trouble. Julie Palmer, regional managing partner of Begbies Traynor, a British restructuring group, estimated that 490,000 U.K. companies were already displaying signs of distress before the virus hit. “If coronavirus affects even 5%, that would double the rate of corporate insolvencies,” she said.
Big banks were likely to focus on the largest corporate clients, putting smaller companies “well back in the queue,” said Campbell Harvey, finance professor at Duke University’s Fuqua business school. “These small and medium-sized firms are often crucial links in the supply chain. If these links are broken, it will be much more difficult to recover from a recession,” he warned.
More than $320 billion of U.S. debt sitting on the lowest rung of the investment grade ladder now yields more than 5%, according to Ice Data Services figures, previously a rate attached to much riskier companies.
The list includes household names, from General Motors and Ford to embattled retailers Nordstrom and Kohl’s. One name on the list, Occidental Petroleum, slashed its dividend last week to guard against further declines.