Corporate Defaults Begin To Snowball

By Eric Fox | February 24, 2009 AAA

This credit cycle has seen its share of defaults and bankruptcies and most observers of the market are sure that there are more to come before we turn the corner. Year to date, after only two months, 31 companies have defaulted on debt totalling $49 billion. Investors can keep track of the activities of the rating agencies to monitor the financial health of companies they own or are interested in. The two major ratings agencies are Moody's (NYSE:MCO) and Standard & Poor's, which is a unit of McGraw Hill (NYSE:MHP)
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Growing Downgrades
A number of companies in a wide range of industries have seen ratings cut deeper and deeper into the non-investment grade or junk category recently as businesses try to cope with the worst business environment in recent memory. (For further reading, see What Is A Corporate Credit Rating.)

Standard & Poor's lowered ratings on Valhi (NYSE:VHI), from B to B-, and placed it on negative credit watch, meaning that the conditions that led to the downgrade is continuing. Valhi's problem is in its titanium dioxide business, which is suffering from weak demand. The chemical compound is used in a range of industrial products including paint, plastics and paper. In its last earnings release in November 2008, the company said volumes fell by 12% from the same quarter last year, offset a little by positive pricing and currency.

TRW Automotive Inc., (NYSE:TRW) saw its rating cut by Standard & Poor's to B+ from BB. The outlook was put at negative. The agency said that with auto sales at 10.3 million units domestically in 2009, the company would see pressure on revenues and may need to renegotiate agreements with lenders.

Another company with exposure to automotive sales is Tenneco (NYSE:TEN) which had its ratings lowered by Moody's to B3 from B1. The company makes emission control and other products. Tenneco reported a GAAP loss of $298 million ($6.40 per share) for its fourth quarter.

One sector where investors rely heavily on the actions of the ratings agency is the financial sector, particularly insurance. Last week, Standard and Poor's downgraded the ratings of Prudential Insurance (NYSE:PRU) from A+ to A. The agency cited "declining earnings and potential for elevated investment losses in the future." The market reaction was quick and the stock fell precipitously once the news became public.

Corporate defaults have started to increase in 2009, and investors should incorporate the actions of the two major ratings agencies into their stock selection. Although they have received criticism for being slow to downgrade the worst of the structured products, they are still important to the investment process.

For further reading, see The Debt Rating Debate.

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