The drama unfolding around the efforts to save commercial lender CIT Group is likely to be repeated many times this year as other American corporations, faced with a heavy load of debt, go to the precipice of bankruptcy.
In an indication of the rising toll of the recession on business, rating agency Standard & Poor's (S&P) expects corporate defaults on risky, non-investment grade bonds to rise from 4.5 percent today to 14 percent by June next year. In the last recession, the agency says the default rate reached a high of 10 percent.
Moody’s, another rating agency, expects the rate this time to be the highest since the Great Depression.
The debt crunch could have some bad consequences. To avoid defaulting, companies may reduce their payroll expenses, curtail their expansion plans, and pare their own purchases back.
In past recessions, excessive corporate borrowing contributed to the downturn. That’s not the case this time. “Going into the recession, the non-financial companies had the best balance sheet,” says Mr. Zandi. “But the severity of the recession is undermining their financial health too.”
Companies on “credit watch”
Through the first six months of the year, S&P says 181 companies have defaulted on their debt – four times the number last year. Through last month, 60 issuers of debt originally worth $209 billion have seen their IOUs downgraded to “non-investment” category.
Companies now on S&P’s "negative credit watch” includes utility Commonwealth Edison, trucking company Con-way Inc., and B/E Aerospace. These companies are on the verge of having their debt considered “non-investment.”
“There is a high probability they will be downgraded. Historically, two-thirds of the companies on negative credit watch get downgraded,” says David Wyss, chief economist for S&P.
Some companies not on credit watch but with BBB- debt – the lowest investment grade – also have a negative outlook. This includes household names such as Dr. Pepper Snapple Group, Dow Chemical, and Wyndham Worldwide. On a historical basis, Mr. Wyss says 30 percent will get downgraded.
A rise in bond lending
Despite the rising defaults, Wyss says there is a resurgence of lending to investment-grade companies. In fact, he says, there is a chance of a record issuance of corporate bonds in the US.
“Partly, it’s because you can’t borrow from the banks,” says Wyss. “And interest rates are so low, if you can, you want to lock in long-term rates now and cut back on your short-term debt.”
This dichotomy in the bond market, between those who have access to credit and those who don’t, may result in more mergers. “If you are a small company out there and can’t borrow money, one of the first things your competition thinks about is, ‘I can buy these guys cheap,’ ” says Wyss.
That's exactly what is happening, says Paul Leinwand, a partner at the consulting company Booz & Co. He says strong companies are buying up weaker companies, aggressively pricing their products, or taking other actions to gain market share.
“These are companies that clearly have stronger economics,” says Mr. Leinwand, author of the e-book, "Cut Costs and Grow Stronger." “They will have the freedom to invest in growth in the future.”
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