Wave of Bad Debt Swamps Companies

By JEFFREY MCCRACKEN and VISHESH KUMAR A growing wave of souring corporate debt claimed another victim on Thursday as Charter Communications Inc., the nation's fourth-largest cable-TV company, said it would seek bankruptcy-court protection by April 1. Charter, which was started by Microsoft Corp. co-founder Paul Allen, said its planned Chapter 11 filing was intended to trim about $8 billion from its $21 billion in debt. After extensive negotiations, a committee of debtholders agreed to the plan, under which Mr. Allen will retain control of the company. Charter's bankruptcy-court filing would be the latest in a succession of corporate setbacks. Earlier this week, Muzak Holdings LLC, known for producing background music, and packaging company Pliant Corp. sought Chapter 11 protection. On Thursday, Aleris International, which produces aluminum products, and the U.S. operations of Midway Games Inc. did the same. Satellite-radio company Sirius-XM Radio Inc. and mall giant General Growth Properties Inc. both face large debt payments in coming days, and are trying to negotiate out-of-court solutions to their problems. The U.S. is entering a period likely to feature the most corporate-debt defaults, by dollar amount, in history. By various estimates, U.S. companies are poised to default on $450 billion to $500 billion of corporate bonds and bank loans over the next two years. In percentage terms, the projections from the three main credit-rating agencies for defaults on high-yield bonds approach levels last seen in 1933, according to an 87-year default-rate history compiled by Moody's Investors Service. The agencies expect default rates on these non-investment-grade bonds to triple to about 14% or higher this year, from around 4.5% last year. The coming default wave is another source of trouble for the global financial system, which already is grappling with hundreds of billions of dollars in defaulted mortgages, credit-card debt, student loans and other consumer debt. Corporate defaults threaten to hurt banks, pension funds and private-equity funds, which in recent years gobbled up high-yield corporate debt and pieces of bank loans. Corporate defaults -- in which companies cannot meet interest or principal payments on borrowed money -- don't always result in Chapter 11 filings. Often borrowers can restructure their debts by working out new payment terms with lenders. Sometimes they agree to give lenders ownership stakes in exchange for reducing or eliminating debt. Such workouts can dilute or wipe out existing shareholders. The defaults will likely be spread across many industries. At the moment, debt-rating agencies are singling out media, entertainment, casino and hotel companies, car makers and retailers as the most distressed sectors. Standard & Poor's Corp. estimates that nearly 90% of 263 rated media and entertainment companies -- a group that also includes hotels and casinos -- are at risk for default, based on their speculative-grade credit ratings. S&P estimates high-yield-bond default rates will hit 13.9% this year, but could go as high as 18.5% if the downturn is worse than expected. Moody's predicts a default rate around 16.4% this year. The default rates in recent downturns were 11.9% in 1991 and 10.4% in 2002, according to S&P. Such rates peaked at around 15% in 1930, according to Moody's. In 2007, when credit flowed freely, the default rate dipped below 1%, an all-time low. At present, nearly two of every three nonfinancial companies have below-investment-grade ratings, says Diana Vazza, a managing director and head of fixed-income research at S&P. That compares with 50% during the last downturn earlier this decade, and one in three during the recession of the early 1990s. "This is the most toxic mix of U.S. corporate ratings we've seen," she says. This year, as of Feb. 6, 21 U.S. companies have defaulted on $43.1 billion of high-yield bond and bank debt, according to S&P. That is greater than the dollar value of defaults in 2006 and 2007 combined, and it's more than 25% of the $157 billion of high-yield-loan and bond defaults in all of last year. Earlier this year, there were bankruptcy filings by technology giant Nortel Networks Corp., chemical and environmental-services firm LyondellBasell Industries and consumer-products giant Spectrum Brands Inc., the maker of Rayovac batteries, Remington shavers and other well-known brands. Many companies are paying the price for buying binges earlier this decade to expand operations or acquire rivals. Charter Communications, which provides cable-TV, broadband and phone services in 27 states, grew rapidly through a series of acquisitions, and then went public in 1999. The purchases saddled it with billions of dollars of debt. Some analysts say Charter overpaid for many of the assets. By last year, with the credit markets in chaos, managing the debt load had become a major concern. Charter, which has 16,500 employees and reported $6.5 billion in revenue last year, doesn't expect to cut jobs as part of its reorganization. At the start of 2007, the ratio of debt to earnings for all industrial companies stood at 4 to 1, according to Fitch Ratings. As companies borrowed more, that number grew to 6 to 1 by the third quarter of 2008. That left less room for error if the economy slipped. Now the debt is coming due -- and defaults are piling up. "You do the math, and it says we are in the midst of the greatest pool of defaulted debt we have ever seen," says Jeffrey Werbalowsky, co-CEO of the investment-banking firm Houlihan Lokey Howard & Zukin, which works on corporate restructurings and bankruptcies. He estimates that about $450 billion in corporate debt will default by the end of 2010. Because many corporate defaults turn into bankruptcies or other cutbacks, there is certain to be a spillover effect on U.S. unemployment, which is already at a 16-year high. Over the past three months, 1.77 million jobs have been shed. With credit still tight, more bankrupt companies might have trouble raising money to restructure, forcing them to liquidate. That's what consumer-electronics retail chain Circuit City did; it employed 35,000 before announcing last month it was shutting its doors for good. "Given the credit crunch, many of these companies may just go away, and that hurts vendors, rivals and customers," says Mariarosa Verde, Fitch head of credit-market research. "What we don't know is the impact of all these defaults on the economy and on jobs or on consumer confidence." Fitch Ratings estimates the biggest prior year for high-yield bond defaults, in dollar terms, was 2002, when $109.8 billion defaulted. In 2008, high-yield bond defaults topped $66.6 billion, up from $9 billion for 2006 and 2007 combined. The rating agencies expect defaults to peak in the second half of the year, based on forecasts that the economy itself will bottom out in the first two quarters of the year. Historically, bondholders recover about 40 cents on the dollar on defaulted high-yield bonds. Fitch's Ms. Verde expects the recovery rate could fall to about 20 cents on the dollar, or lower, in this recession. That's because the economic downturn is so severe, and distressed companies are carrying so much more debt than in the past. Write to Jeffrey McCracken at jeff.mccracken@wsj.com and Vishesh Kumar at vishesh.kumar@wsj.com