Capital Markets

Defaults: Neither De-lovely, Nor De-marvelous

Worst credit climate since the depression, says Moody's. Plus: look who's cozying up to analysts.
Stephen Taub and David CampbellMarch 5, 2003

We’ll slip in the good news first.

Turns out that fewer corporate issuers defaulted on rated bonds in 2002, according to Moody’s Investors Service’s annual study of global defaults and ratings performance. All things considered — a neat trick — that would seem like a sign that corporate health is on the improve.

But ominously, Moody’s says the total dollar volume of defaulted debt last year soared to over $163 billion. That’s a 60 percent jump from the $106 billion in the dollar volume of defaults in 2001.

During 2002, 141 corporate bond issuers defaulted on their bonds, down from 186 in 2001. The default rate for all Moody’s-rated corporate bond issuers fell to 3 percent, compared with 3.8 percent in 2001.

When measured in dollar terms, though, the rate for all corporate issuers increased to 5.3 percent in 2002, up from 4.2 percent in 2001.

The default rate for speculative-grade rated issuers fell to 8.3 percent in 2002, down from 10.6 percent the year before. As a percentage of dollar volume, however, the speculative-grade default rate jumped to 21 percent in 2002 from 18 percent in 2001, said the credit rating agency.

“The duration and depth of the current credit cycle has eclipsed that of the 1990-91 period and, in fact, has not been matched since the 1930s,” said David T. Hamilton, Moody’s director of corporate bond default research.

Hamilton says the decline in corporate credit-worth is largely the product of three factors: the unprecedented issuance volume of very risky speculative-grade securities in the late 1990s, the slow economic growth of the last two years, and the recent wave of corporate accounting scandals.”

Altogether, Moody’s figures there were 20 defaults that topped $1 billion each, quadrupling the 1983-2001 average default size to $1.7 billion.

The largest default in 2002? No surprise here: WorldCom, Inc. The teetering telco defaulted on over $23 billion of bonds in July 2002. In fact, more than half of last year’s defaults by dollar volume occurred in the telecommunications sector.

Indeed, it’s been over thirty years since a single sector so dominated the annual debt default total. Back in 1970, 83 percent of defaulting issuers were in the transportation sector.

U.S.-domiciled issuers comprised 68 percent of all defaulters, down from 77 percent in 2001.

Europe’s share of the global defaults rose sharply last year, to just over 19 percent, up from 7 percent in 2001.

The percentage of corporate debt issuers downgraded in 2002 and 2001 also reached record highs.

One-quarter of speculative-grade issuers received downgrades in 2002 while 22 percent of investment-grade corporations received downgrades. The number of “fallen angels” (a debt issuer whose rating falls from investment to speculative grade) more than doubled, to 5.2 percent last year.

“The high, but slowing pace of rating downgrades suggests that while credit stress will remain high this year, we should see some improvement,” Hamilton said.

Cozying Up to Analysts

In an attempt to provide a more open line of communication with investors and analysts, many companies are ditching the canned presentation in favor of an informal meeting heavy on question-and-answer periods.

Impromptu dialogues — sometimes called “fireside chats” — are more effective at making a strong impression, say investor-relations experts, but they also raise the risk of running afoul of Regulation Fair Disclosure (Reg FD).

Hoover’s Inc. CFO Lynn Atchison says the Austin, Texas-based business-information company hasn’t gone down the road less scripted. “I would be wary of regulatory fair-disclosure implications,” she says. (Impromptu dialogue increases the risk that an executive could mistakenly reveal material information to a select group, which is prohibited by Reg FD.)

“There is certainly a premium on the kinds of skills possessed by those who are comfortable talking to investors in an informal setting,” says Bob Dentzman, treasurer and vice president of investor relations at Herman Miller Inc.

Last April, the Zeeland, Michigan-based office-furniture manufacturer hosted a “kitchen-table talk” as part of an investor visit organized by UBS Warburg Ltd. analyst Margaret Whelan. Dentzman says the informal format of the Warburg meeting, a departure from the conventional scripted presentations of the past, is typical of the way Herman Miller now conducts investor visits.

“The analysts and investors had the opportunity to see us firsthand; to talk with Beth Nickels, our CFO; and to see how we interacted with people — you lose that with a scripted presentation,” says Dentzman.

Ron Graziano, of Chicago investor-relations firm Ashton Partners, says fireside chats may be right for some companies, but they’re not for everyone. “At some companies the message is still being worked out, or the CEO has a reputation for being overly optimistic or saying things he shouldn’t.” For those who are uncomfortable speaking off-the-cuff, Graziano recommends sticking to the script.

Louis Thompson, president of The National Investor Relations Institute, says the dangers are overblown. “Reg FD is not the big bear in the closet that keeps companies from engaging in open discussion with investors,” says Thompson. But if you do slip, he adds, the rules allow 24 hours to revise disclosure with a press release.

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