2012 DEBT WALL - A DISASTER OF A DIFFERENT KIND

[ZyeCha Inc. CEO/Founder PRINA]

When the Mayans envisioned the world coming to an end in 2012 — at least in the
Hollywood telling — they didn’t count junk bonds among the perils that
would lead to worldwide disaster.

Maybe they should have, because 2012 also is the beginning of a
three-year period in which more than $700 billion in risky, high-yield
corporate debt begins to come due, an extraordinary surge that some
analysts fear could overload the debt markets.

With huge bills about to hit corporations and the federal government
around the same time, the worry is that some companies will have trouble
getting new loans, spurring defaults and a wave of bankruptcies.

The United States government alone will need to borrow nearly $2
trillion in 2012, to bridge the projected budget deficit for that year
and to refinance existing debt.

Indeed, worries about the growth of national, or sovereign, debt
prompted Moody’s Investors Service to warn on Monday that the United
States and other Western nations were moving “substantially” closer to
losing their top-notch Aaa credit ratings.

Sovereign debt aside, the approaching scramble for corporate financing
could strain the broader economy as jobs are cut, consumer spending is
scaled back and credit is tightened for both consumers and businesses.

The apocalyptic talk is not limited to perpetual bears and the rest of
the doom-and-gloom crowd.

Even Moody’s, which is known for its sober public statements, is
sounding the alarm.

“An avalanche is brewing in 2012 and beyond if companies don’t get out
in front of this,” said Kevin Cassidy, a senior credit officer at
Moody’s.

Private equity firms and many nonfinancial companies were able to borrow
on easy terms until the credit crisis hit in 2007, but not until 2012
does the long-delayed reckoning begin for a series of leveraged buyouts
and other deals that preceded the crisis.

That is because the record number of bonds and loans that were issued to
finance those transactions typically come due in five to seven years,
said Diane Vazza, head of global fixed-income research at Standard &
Poor’s.

In addition, she said, many companies whose debt matured in 2009 and
2010 have been able to extend their loans, but the extra breathing room
is only adding to the bill for 2012 and after.

The result is a potential financial doomsday, or what bond analysts call
a maturity wall. From $21 billion due this year, junk bonds are set to
mature at a rate of $155 billion in 2012, $212 billion in 2013 and $338
billion in 2014.

The credit markets have gradually returned to normal since the financial
crisis, particularly in recent months, making more loans available to
companies and signaling confidence in the pace of economic recovery. But
the issue is whether they can absorb the coming surge in demand for
credit.

As was the case with the collapse of the subprime mortgage market three
years ago, derivatives played a big role in the explosion of risky
corporate debt. In this case the culprit was a financial instrument
called a collateralized loan obligation, which helped issuers repackage
corporate loans much as subprime mortgages were sliced, diced and then
resold to other investors. That made many more risky loans available.

“The question is, ‘Should these deals have ever been financed in the
first place?’ ” asked Anders J. Maxwell, a corporate restructuring
specialist at Peter J. Solomon Company in New York.

The period from 2012 to 2014 represents payback time for a Who’s Who of
private equity firms and the now highly leveraged companies they helped
buy in the precrisis boom years.

The biggest include the hospital owner HCA, which was taken private in
2006 by a group led by Bain Capital and Kohlberg Kravis & Roberts
for $33 billion, and has $13.3 billion in debt payments coming due
between 2012 and 2014. Another buyout led by Kohlberg Kravis, for the
giant Texas utility TXU, has $20.9 billion that needs to be refinanced
in the same period.

Realogy, which owns real estate franchises like Century 21 and Coldwell
Banker, was taken private by Apollo in the spring of 2007 just as the
housing market was beginning to unravel and as the first tremors of the
subprime crisis were being felt.

Realogy was saddled with $8 to $9 of debt for every $1 in earnings, well
above the “$5 to $6 level that is manageable for a company in a highly
cyclical industry,” according to Emile Courtney, a credit analyst with
Standard & Poor’s.

Realogy has survived — barely. “The company’s cash flow is still below
what’s needed to cover the interest on its debt,” Mr. Courtney said.

Realogy said it ended 2009 with a substantial cushion on its financial
covenants and over $200 million of available cash on its balance sheet.
“The company generated over $340 million of net cash provided by
operating activities in 2009 after paying interest on its debt,” the
company said.

Not everyone is convinced that 2012 will spell catastrophe for the junk
bond market, however.

Optimists like Martin Fridson, a veteran high-yield strategist, note
that investors seeking high yields snapped up speculative-grade bonds
last year and early this year, and he suggests that continued demand
will allow companies to refinance before their loans come due.

“The companies have nearly two years to push out the 2012 maturity
wall,” he said. “Of course, the ability to refinance will depend upon
the state of the economy.”

That is still a wild card, but even if the economy improves, companies
with a lot of debt will be competing with a raft of better-rated
borrowers that are expected to seek buyers of their debt at around the
same time.

Chief among those is the best-rated borrower of all: the United States
government. The Treasury Department estimates that the federal budget
deficit in 2012 will total $974 billion, down from this year’s $1.8
trillion, but still huge by historical standards.

Most critics of deficit spending have focused on the budget gap alone,
but Washington will actually have to borrow $1.8 trillion in 2012,
because $859 billion in old bonds will come due and have to be
refinanced in addition to the deficit. By 2013 and 2014, $1.4 trillion
will have to be raised annually.

In the late 1990s, the federal government ran a surplus and actually
paid down a small portion of the national debt. But with the huge
deficits of the last few years, the national debt has grown to more than
$12 trillion.

Next in line are companies with investment-grade credit ratings. They
must refinance $1.2 trillion in loans between 2012 and 2014, including
$526 billion in 2012. Finally, there is the looming rollover of
commercial mortgage-backed securities, which will double in the next
three years, hitting $59.7 billion in 2012.

Even if most of the debt does get refinanced, companies may have to pay
more, if heavy government borrowing causes rates for all borrowers to
rise.

“These are huge numbers,” said Tom Atteberry, who manages $5.6 billion
in bonds for First Pacific Advisors, and is particularly alarmed by
Washington’s borrowing. “Other players will get crowded out or have to
pay significantly more, because the government is borrowing so much.”

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