Moody's says defaults to peak higher, later than previously forecast

By Peter Heap

New York, Sept. 24 - Moody's Investors Service said Monday that the terrorist attack on Sept. 11 will cause the high-yield bond default rate to peak at a higher level and later in time than previously forecast. But the rating agency also drew attention to a silver lining in that the market response has not been as pessimistic as the last major trouble in 1998.

Defaults are now expected to hit "just over" 11% in the middle of 2002 before declining, said David Hamilton, Moody's principal default analyst in a conference call. At its last forecast, made in August, Moody's had seen defaults hitting a high of 10% in February or March. Both figures cover all speculative-grade issuers worldwide. For 2001, Moody's now sees defaults coming in at 10% compared to 9.5% previously.

Hamilton also cautioned against paying too much attention to positive signs over couple of months preceding the tragedy - although he went on to draw attention to some positive signs.

"The improvement in high yield that seemed to be emerging prior to Sept.11, all bets are off," Hamilton said.

He added that the global default rate in August was 8.8%, up from 8.5% in July. That continued a trend of defaults outpacing Moody's forecasts; a year ago Moody's model had predicted an 8.5% rate in August.

So far this year, $67.7 billion of junk bonds have defaulted from 173 issuers. In August, the total was $4.7 billion and 14 issuers. By comparison, 2000 as a whole saw $49.1 billion of defaults.

"This year is going to turn out to be a massive, massive year in terms of the dollar volume of defaults," Hamilton told the conference call.

U.S. rates have been running ahead of the rest of the world. In August, the U.S. rate was 9.4%, up from 9.1% in July. But as time goes on, Hamilton believes rates in the U.S. and elsewhere will converge.

But despite the gloom, Hamilton noted some positive indicators, especially compared to the late summer of 1998 when Russia defaulted and Long-Term Capital Management collapsed.

While high-yield spreads have widened significantly, the move out has been a relatively modest 100 basis points compared to 250 basis points or even 300 basis points in the troubles of 1998.

Similarly, the decline in liquidity has been "nowhere near as bad" as 1998, he added.

"Although it's short-term negative, once you put it into context it's long-term positive," Hamilton said.

"I think there is a silver lining to these dark clouds and that we do continue to expect a drop off in the default rate in the second half of 2002."

Also during the conference call, Moody's said it is dropping its outlook on the leisure and gaming sector to negative from stable. All other sectors covered during the call already have a negative outlook.

"Overall the tragedy that happened will have a material impact on the credit of all these leisure sub-sectors," said sector analyst Keith Foley, looking at hotels, lodging, resorts, skiing and gaming.

At the moment Moody's is particularly wary of companies that have high debt levels for their ratings, companies dependent on customers traveling long distances, companies selling assets and companies that pursue share repurchases at the expense of credit quality.

But that, Foley noted, "pretty much covers the gamut of the gaming and leisure industry."

He was particularly concerned:

--Lodgian, Inc. (B3 senior implied rating with a negative outlook) which is trying to sell assets and refinance its bank agreement;

--ShoLodge, Inc. (B3 senior impled with a stable outlook) which only recently regained its stable outlook;

--Sun International Hotels Ltd. whose single property, The Atlantis, is heavily dependent on the travel and cruise industry;

--Boyd Gaming Corp. and Isle of Capri Casinos, Inc., both of which have high debt levels and require deleveraging to maintain their current ratings.

But Foley was positive about Aztar because of its exposure to Atlantic City, which is likely to do well give that visitors tend to drive their and because thanks to deleveraging it has the most financial flexibility of any of the gaming credits.

In the media sector, Moody's analyst Christina Padgett warned that trade show organizers would likely be hard hit by the reluctance to travel, in particular Advanstar Inc., Key3Media Group Inc., and Penton Media, Inc.

Stronger, however, are likely to be outdoor advertising companies since this sector is the lowest cost means of reaching customers. Some companies reported no cancellations as of last week, Padgett said.

In technology, analyst Howard Sitzer cautioned on Solectron Corp. and SCI Systems Systems Inc.

On Solectron, Sitzer warned that "excessive reliance" on zero-coupon convertibles exposed the company to the exercise of puts by bondholders in the near future. The contract electronics manufacturer had also accumulated "enormous" inventories, he added.

While the combination of SCI Systems and Sanmina Corp. will create a "formidable and well-balanced" player, Sitzer said that with the uncertain outlook SCI is now unlikely to see an upgrade once the merger is complete.

He also praised four companies - Viasystems Group, Inc., International Rectifier, TranSwitch Corp. and Vitesse Semiconductor Corp. - for their substantial cash positions. He described them all as well positioned. That included TranSwitch and Vitesse since the deleveraging benefits of convertible repurchase programs have helped them at a time of particularly dig drops in demand.

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