The federal government is taking unprecedented action to keep American businesses alive during the coronavirus pandemic.
Congress has set aside hundreds of billions of dollars to lend to small, medium and large companies. Small businesses have taken out more than half a trillion in forgivable loans. And for the first time ever, the Federal Reserve will direct the purchase of corporate bonds, including junk bonds.
Yet the Chapter 11 filing Monday by J.Crew is a fresh reminder that Uncle Sam can’t bail everyone out. Companies that were on the ropes long before the pandemic struck, like J.Crew, will be forced to restructure their piles of debt in bankruptcy court. And some of them won’t survive.
“Fed liquidity doesn’t solve corporate solvency. That’s the bottom line,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group.
There are limits to the federal government’s efforts. The weakest companies entering the crisis won’t have access to the lending facilities rolled out by the Fed and Treasury Department.
J.Crew is the first US national retailer to go bankrupt during the crisis. But it surely won’t be the last. Analysts are warning that Neiman Marcus, JCPenney, GNC and many more are also on the brink.
It’s not just retail, of course.
Hertz, Norwegian and Gold’s Gym
Gold’s Gym, which owns 700 fitness centers around the world, filed for bankruptcy on Monday. The 55-year-old company says it’s “absolutely not going anywhere” and plans to emerge from its restructuring by August 1.
Outside the hurting retail industry, car rental giant Hertz plummeted Tuesday on reports it’s preparing for a bankruptcy filing of its own. Hertz secured a temporary lifeline from lenders as it tries to figure out a way to survive.
The cruise industry is also getting clobbered by the health crisis. Although Carnival was able to raise the funds it needed to survive, rival Norwegian warned Tuesday it “does not have sufficient liquidity” to meet its obligations over the next year.
And then there’s the once-booming US oil industry. Whiting Petroleum and Diamond Offshore both filed for bankruptcy last month, kicking off what will likely amount to dozens of Chapter 11 filings because of the collapse in prices.
Not all junk bonds accepted
These early bankruptcies highlight the limits to the federal government’s rescue efforts. It can’t, and shouldn’t, save everyone.
For instance, the Fed recently expanded its Main Street lending program to welcome larger companies and ones with more leverage.
Under a new loan option, companies can borrow up to $25 million if total debt does not exceed six times a borrower’s income, adjusted for interest payments, taxes and other items. Still, that means some companies will have too much debt to qualify for this program.
Likewise, the Fed has promised to set up a vehicle that will buy not just strong investment grade rated debt, but junk bonds, too.
However, companies with the weakest credit ratings can’t participate. The US central bank said that companies must be rated at BB- or above. That would exclude the likes of Hertz, JCPenney and fracking pioneer Chesapeake Energy.
Another Fed facility will soon directly buy debt issued by companies in bond sales. But again, those companies must have a credit rating at BB- or above. And the Fed said that companies that wish to participate in this lending facility must certify in writing that they are “not insolvent.”
In other words, some companies that were already teetering on the edge of bankruptcy can’t count on bailouts from Washington.
20% of junk-rated retailers and restaurants could default
That’s why S&P Global Ratings has warned that the J.Crew bankruptcy is the beginning of a “broad shakeout of retail.”
The ratings company said about 30% of the retail and restaurant companies it covers are now rated CCC+ or lower, implying at least a 50/50 chance of default. S&P expects the default rate among junk-rated retail and restaurants to spike to nearly 20%.
The problem is that the balance sheets of some companies like J.Crew were troubled long before coronavirus infections mounted. The 2011 leveraged buyout of J.Crew by private-equity firms TPG Capital and Leonard Green saddled the retailer with excess debt. Long-term debt skyrocketed from $50 million in 2010 before the LBO to $1.7 billion as of February 1.
Neil Saunders, managing director at GlobalData Retail, called that debt a “millstone” around J.Crew’s neck that’s “crippling the business.”
Saunders said the Chapter 11 filing arguably should have been “done years ago,” but the coronavirus crisis “forced the situation to a head.”
It won’t be the last company in that situation.
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