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Financial health of U.S. corporations starting to improve: study Print E-mail
Saturday, 26 September 2009

By Ronald Fink

The creditworthiness of U.S. corporations is on the mend, thanks to a bottoming out of profit margins and lower leverage, new research shows. As a result, the rate of corporate defaults should slow in coming months, at least in the U.S.

According to the report published Friday by research firm CreditSights, the downturn in profit margins for non-investment grade U.S. corporate issuers that began more than two years ago has leveled out at around 7.5 percent. Margins have fallen sharply from well over 9 percent in early 2007.

Meanwhile, CreditSights found that the leverage of issuers of high-yield debt has fallen to roughly 70 percent of capital from almost 100 percent at the beginning of this year, based on asset market values.

Of course, that was driven in part by the sharp rally in equity prices during the second quarter, which reduced debt in proportion to equity, rather than by debt repayment exclusively. As a consequence, the improvement in balance sheet strength could rapidly reverse if the economic recovery fails to live up to expectations and equity prices fall again.CreditSights also noted that the volatility of asset values remains high.

What's more, as CFOZone reported today, the credit-quality of syndicate loans have plummeted since last year. Indeed, $53 billion in shared loan facilities are now seen as uncollectable - a 300 percent increase from last year.

Even so, analyst Kai Gilkes wrote that "the worst is probably over" for U.S. corporate defaults. Since the downturn began in September 2008, the percentage of U.S. high-yield issuers defaulting on their debt has climbed from the low single digits to more than 10 percent, with companies in the automotive, media and cable industries accounting for roughly two-thirds of those defaults.

Despite the improvement, Gilkes noted that the rate of corporate defaults is likely to remain higher than it was prior to the downturn because the economic recovery is likely to be weak. Meanwhile, defaults in Europe may continue to climb, since economies there have been slower to recover from recession.

Also, more European companies have been financed with bank loans rather than bonds. That makes it more difficult for those companies to refinance when they get in trouble.

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