Bangkok--20 Sep--Standard & Poor's Given the current uncertainties surrounding financial market access by U.S. corporations, Standard & Poor's Ratings Services has been reviewing the liquidity status of all rated corporate companies. This surveillance effort is important in today's market, which is characterized by heightened credit risk, a more cautious approach by investors, and more limited financing available in the short-term commercial paper markets and the high-yield loan and bond markets. We have found that companies rated in the 'BB' category and higher are generally well positioned to weather at least several months of market turbulence. However, companies rated in the 'B' category and lower are most vulnerable, considering the current market volatility and that cash liquidity is the lifeblood of these firms. The favorable borrowing environment these past few years spurred a surge in the number of highly leveraged 'B' category new debt issuers. While near-term rating activity has been, and will continue to be, muted because immediate cash needs for refinancings are not substantial, we anticipate the increase in low-quality credit borrowers to lead to a rise in defaults over the next year. U.S. corporate defaults in 2007 have totaled only $4.5 billion (15 defaults) thus far, but that could rise to more than $35 billion over the next 15 months based on the default risk inherent in the weakest 75 U.S. corporate credits. This projection could actually be conservative if the present credit and economic environments deteriorate similarly to the 2001-2002 period, when $250 billion of corporate debt defaulted. (See "Global Bond Markets' Weakest Links And Monthly Default Rates," published Sept. 12, 2007 on RatingsDirect.) Standard & Poor's Review Looks Out Over Next 8-12 Months Our review focused on each company's ability to finance itself, with a presumption that access to markets--for both raising funds and selling assets--would be difficult. We concentrated on the next 8-12 months, as we believe the current credit crunch could last for some time. The analysis looked at companies' debt maturity schedules and their ability to borrow under credit lines or tap other backup sources, including cash on hand. We did not look at liquidity metrics alone in assessing companies' vulnerability; our analysis also included companies' standing with regard to loan covenants and their ability to fund themselves from within. Liquidity analysis is an important part of our regular ongoing analytical methodology. Among other analytical processes, analysts identify the companies where liquidity is an immediate area of concern. In the period prior to the current market disruption, we identified nearly one hundred credits (out of nearly 2,000 U.S. industrial and utility companies) that required special attention be paid to their liquidity situation. Of these, two-thirds were rated in the 'B' category. (Homebuilders were not part of this review. The homebuilders are being reviewed separately, given their more direct involvement with the current housing market issues. The results of that review will be published in the near future.) Results--and other analytical thoughts As one would expect, highly rated companies have fared much better than others, and investment-grade bond issuance has indeed been robust over the past six weeks. But liquidity cannot be taken for granted in the current environment. Investors have become broadly more risk-sensitive, reversing a long period of seeming indifference to risk. (See "The Leveraging of America: A Rising Tide Of Riskier Credit," published May 22, 2007 on RatingsDirect.) As previously mentioned, the results for credits rated in the 'BB' category and above were benign. Many of these companies already have negative rating outlooks, which may reflect their own specific liquidity risks. The current market environment, while challenging in our opinion, does not in itself warrant any rating revisions on individual companies. One reason for this relatively positive outcome is that a comparatively small amount of debt maturities is coming due in the near future. This is especially true for bond repayments, in part because of the tremendous market liquidity in recent periods that has allowed many companies to refinance and push out maturities. (See "The U.S. Power Sector Appears Well Positioned To Manage Near-Term Refinancing Requirements," published Aug. 30, 2007 on RatingsDirect.) In contrast, companies with low ratings are most vulnerable. The large group of credits rated 'B' and below (which constitutes more than 40% of non-financial corporate ratings in the U.S.--up from 35% a decade ago) faces more significant challenges relating (both directly and indirectly) to the changed environment. Such vulnerabilities are reflected in the low ratings assigned to these entities, which tend to be the most highly leveraged companies with the weakest business dynamics. The typical 'B' category credit had an average debt-to-EBITDA ratio of 6.0x in 2006. Moreover, as new issuer ratings have migrated down the 'B' category, leverage of much higher than 6.0x has become more common. These companies are highly reliant on financial market access to support operational cash needs, but the plentiful liquidity for high-yield borrowers is almost surely a thing of the past. In our view, over the coming year, there are some risks of a protracted economic slump, a sustained rise in borrowing costs, and the inability to satisfactorily execute planned asset sales--any one of which would greatly impair this category of credits. There is still uncertainty as to whether the U.S. economy will soon enter a recession, as the data is still positive. (U.S. real GDP grew 3.4% in the second quarter, and we expect it to hold at 2.0% through the rest of 2007--near the average of last year's final three quarters.) Still, the recent expansion has been fueled by consumer spending, much of it attributable to the so-called "wealth effect" stemming from the real estate bubble. There could well be lagging effects on consumers from mortgage defaults, home price devaluation, high commodity prices, etc. As with our economic outlook, we see few near-term signs that a surge in benchmark interest rates will weigh on companies' ability to service their variable-rate debt. But any increase in borrowing costs as the credit markets re-price risk, combined with a downturn in business activity if consumers become wary of spending, may at some point become a cause of credit downturn. Speculative-grade borrowers face the greatest challenges, both regarding their ability to refinance in the future and in the event of an economic decline. Over the past two to three years, we have expressed our opinion that this group is vulnerable, and that defaults within it will rise substantially, from their recent record-low levels. We reiterate that the ratings on these borrowers are not being revised due to the current market conditions--but we do expect defaults to eventually increase, consistent with the already-stated rating profiles. Longer Term Risk In Central Banks' Hands The credit crunch may well linger into 2008, and will presumably resolve itself as the financial markets re-price existing securities and begin to absorb the multibillion dollars of committed underwritten debt that is impairing banks currently. However, the markets could deteriorate further and the downturn may last for a much longer period if the world's central banks do not support the global capital markets--particularly the structured finance markets. A scenario of prolonged liquidity concerns in the capital markets, combined with a recession resulting therefrom, could result in a much more severe uptick in 2008 U.S. corporate defaults. Complete ratings information is available to subscribers of RatingsDirect, Standard & Poor's Web-based credit analysis system, at www.ratingsdirect.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com; under Credit Ratings in the left navigation bar, select Find a Rating, then Credit Ratings Search. Media Contact: Edward Sweeney, New York (1) 212-438-6634 [email protected] Analyst Contacts: Paul Coughlin, Executive Managing Director, New York; Solomon B Samson, Managing Director, New York (1) 212-438-7653; John J Bilardello, Managing Director, New York (1) 212-438-7664;