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Moody’s: Number of Distressed Retailers “Eclipses” Great Recession Rates

The number of distressed retail and apparel companies is on the rise.

Moody’s Investor Services reports that as of May, 22 companies are rated Caa or lower. That’s up from 19 in February.

Of the 148 companies in its portfolio 15 percent are distressed. This “eclipses levels in the Great Recession” in 2009 when the number of such companies comprised 16 percent of the list.

Despite this news, the agency insists that the sector is “fundamentally healthy,” but says trouble spots are growing.

In Moody’s last report on this topic in March, Rue 21 was one of the retailers it called out for being on the bubble. Since then, the chain has filed for bankruptcy. Now, Gymboree is on the hot seat after having missed an interest payment on June 1.

Read about the number debt is doing to the retail sector: Moody’s: Retail Distress Reaching Recession Level

While the majority of the companies in Moody’s B3 and B2 categories are considered stable, the agency warns that companies with these rankings are in a precarious position. “We caution that stable outlooks for companies rated this low can change quickly, because liquidity is usually the overriding factor in determining whether downward migration occurs. For example, we downgraded Vince, LLC to Caa1 from B3 stable on April 20 this year due to operating income pressures that will squeeze liquidity,” the report says.

Liquidity will continue to be a question as $1.1 billion in maturities are set to come due in 2018. Seven B3 rated companies represent 97 percent of that total. These maturities come at a time when default rates are already elevated. While retail in general has a 5 percent default rate, apparel speculative-grade retail is forecast to be 6.8%, making it the highest rate of any spec-grade group, including retail as a whole at 5.8%.

Spec-grade maturities for the next three years are up 3 percent to $158 billion, an all-time high. Accordingly, Moody’s says, refund risks will increase over the next three years

“Many distressed issuers or potential candidates on our B2/B3 list are there because some were targets of an LBO involving leverage that far exceeded their earnings power, or due to platforms and products that have not been big, diverse or nimble enough to succeed against more diversified retailers,” the report stated.

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Looming debt maturity increases risk but some are more manageable than others. Asset based loans are the easiest to expend followed by bank revolvers, term loans and bonds. With that in mind, Moody’s rates the liquidity for companies in its portfolio by type of debt and maturity date. These are important factors given that liquidity is a leading aspect in how a company’s credit is rated, which determines if they’ll ultimately tumble down the ratings.

While there are five characteristics that are often common among Caa/Ca rated firms, Moody’s points out that in some cases mitigating factors can save a company from sliding into distressed territory. Most Caa/Ca apparel and retail firms have “stressed liquidity, weak quantitative credit profiles, challenged competitive positions, sponsor ownership and erratic management structure.”

Moody’s provides the example of Toys R Us, which by some accounts looks like it should be in the distressed category, to illustrate elements that positively affect ratings. For the retailer, this includes maintaining its status as a go-to for toys, the company’s ability to maintain sales even in a highly promotional market and its strong vendor relationships. All of this, the agency says, balances out the company’s hefty debt from leveraged buyouts and refinancing.