OUTLOOK '09: Credit turmoil will persist in 2009

02 January 2009 16:01  [Source: ICIS news]

By Al Greenwood

HOUSTON (ICIS news)--Financial markets will remain tight in 2009, and chemical companies will likely struggle to secure capital, refinance debt or obtain any type of financing during a bankruptcy process, a law professor said.

"It is a very, very difficult situation right now financially," said Jack Williams, a law professor at Georgia State University. Williams is also a resident scholar at the American Bankruptcy Institute.

"Times are going to get much worse before they get better," he said. Overall, US financial markets still have not recovered from their collapse more than a year ago.

Chemical companies will face pressure from both creditors and suppliers, said Kyle Loughlin, team leader of the North American chemicals steam for Standard & Poor's (S&P).

The global chemical community was rocked this week when LyondellBasell revealed it was mulling filing for bankruptcy protection to cope with credit pressures.

Suppliers are becoming more leery of extending credit to customers, he said. In general, they are tightening up terms or cutting off credit altogether, putting strain on working capital.

At the same time, chemical companies are contending with weak demand, Loughlin said. The economic downturn can hurt their credit ratings because many debt covenants include performance benchmarks.

Such benchmarks often require minimum levels for earnings. If companies do not meet those benchmarks, they could fall out of compliance with their debt covenants and would have to renegotiate with their lenders.

As companies struggle with both a weak economy and tight credit, Loughlin said the chemical firms most likely to survive are investment-grade firms, which have more diverse businesses in more specialty niches. “Those that have proven to be resilient continue to hold up pretty well,” he said.

Investment-grade credit is defined as “BBB-“ or higher, according to S&P.

By contrast, speculative-grade firms will struggle, with 30% already having negative outlooks, he said.

Already, speculative-grade default rates for all industrials have surpassed 3%, Loughlin said. During 2007, the rate was less than 1%.

Next year, the speculative-grade default rate could exceed 7.5% in October, Loughlin said. If the US economy weakens beyond expectations, the rate could reach 9.5%.

For the economy as a whole, Williams said 2009 corporate bankruptcies could rise by 40% year over year. Among those bankruptcies, liquidations could outnumber rehabilitations by a margin of three to one.

In the past, that ratio was reversed, Williams said. However, since credit markets will remain tight in 2009, companies will have a much more difficult time securing debtor-in-possession (DIP) financing in a bankruptcy.

Companies rely on DIP financing to fund their day-to-day operations during bankruptcy. Without such financing, debtors will likely liquidate instead of reorganise.

In fact, less than five firms are now regular participants in DIP financing markets, Williams said. Before the credit crisis, there were up to 40 firms.

"You've got a situation where it is extremely difficult to attract the financing necessary to continue operations in bankruptcy and ultimately exit from bankruptcy," he said.

The tight credit reflects the financial crisis that stared more than a year ago, when US house owners started defaulting on subprime loans, Williams said.

Those subprime mortgages, though, illustrate a larger phenomena, Williams said. Before the mortgage defaults, the US housing market had been in a prolonged boom, fuelled by cheap credit.

"When money is really cheap, you can hide a lot of mistakes," Williams said. Sloppiness infects management, finances and regulations.

"Recessions are the market's way of imposing discipline on runaway economies," Williams said.

Given the length of the previous boom, Williams said, companies will work through a lot of mistakes.

Paul Hodges studies key influencers shaping the chemical industry in Chemicals and the Economy
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By: Al Greenwood
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