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Weakening internal cash flow, looming debt maturities, and tighter covenants will spawn a liquidity shortfall for non-financial companies in 2009, according to a new report by the rating agency.
Marie Leone, CFO.com | US
December 23, 2008
Over the next year, 10 percent of public companies will face liquidity shortfalls unless management is successful in raising cash or reducing cash consumption, says a new report from Moody's Investors Service. As expected, the percentage rises above 10 percent for junk-rated companies.
The grim prediction comes despite assurance from Moody's that most investment-grade companies "should have sufficient" liquidity to cover debt maturities and other cash overflows over the next 12 months. Still, companies that run into liquidity problems will find it tough to service debt related to commercial paper and revolving credit lines.
The report is based on a survey conducted at the end of the third quarter of 1,529 non-financial, non-utility corporate issuers with credit ratings of B3 and above. Of the total, 399 companies are investment grade, while 1,130 are speculative grade.
While most companies should have enough liquidity to survive 2009, banks are less willing to renew and extend credit lines, and are insisting on significantly tighter terms, Moody's says. That could cause problems even for companies with solid cash flows, acccording to the report.
The credit rating agency estimates that non-financial companies will have current maturities — bonds and bank loans — amounting to $233 billion in 2009.
Moody's reckons that 9 percent of the investment-grade issuers and 41 percent of the junk issuers are subject to covenants with less than 20 percent headroom under required agreement levels. The report suggests that even companies with "solid business models, tenable financial structures, and sound operating prospects" that are able to renegotiate debt agreements may face materially higher borrowing costs as bank loans are re-priced.
The report also looks at broken covenants, noting that only about 1 percent of investment-grade companies face a medium likelihood of violating covenants, while 15 percent of non-investment-grade issuers face the same situation.
Overall, Moody's believes that "liquidity erosion will be more severe if credit markets remain dysfunctional for a protracted period or if a deep recession badly undercuts operating cash flow." One of the market factors that could further weaken corporate liquidity is a sagging bond market, in which bonds would be viewed as a less reliable funding alternative than in the past — particularly for high-yield issuers.
Also, Moody's expects to see a rise in the number of issuers unable to get a waiver or reset their debt covenants. Such an increase will likely trigger acceleration of debt repayment and a "possible spiraling into bankruptcy."
The study, which was based on free-cash-flow modeling, is subject to the vagaries of that type of forecast, says the report. As a result, the predicted liquidity shortfall may be affected by several key factors. For example, to shield themselves from a shortfall, companies may conserve cash by reducing capital spending or dividends, and prudently managing working capital.
Still, Moody's predicts that over the next year, free cash flow will be substantially reduced compared to what companies had previously forecast. The slowdown in cash generation will make it hard for companies to deal with liquidity pressures, adds the report.
Fallout from the liquidity crisis will also affect corporate credit ratings. "Because near-term liquidity concerns can trump longer-term fundamentals, credit quality and rating may change more quickly for companies that face likely covenant violations and have weak liquidity profiles," concludes Moody's.