Interest Ratio Coverage (from WSJ)

What Is the Interest Coverage Ratio?

It measures a company’s ability to make its debt payments. Why it matters

The ratio can be calculated by dividing operating income—typically defined as earnings before interest and taxes, or EBIT—by its interest expense. (There are variations, but this is the simplest.)

“If your coverage ratio is 1, then you have no cushion,” says Dan Gode, accounting professor at the New York University Stern School of Business. Simply: When a company’s operating earnings are equal to its borrowing costs (giving it a coverage ratio of 1.0), there is no margin for error. If the business meets a rough patch and earnings drop, then the company might not be able to pay the interest on its loans. “If the ratio is north of 3 or 4, then you have some cushion,” Prof. Gode adds.

Speculation over the Federal Reserve’s interest-rate intentions comes into play. Higher interest rates for corporate borrowing will push coverage ratios down unless profits increase. For some companies, that won’t matter much; for others, it will make an already heavy debt burden harder to bear.

“Overall corporate debt might not be high, but that masks great variation” among firms, Prof. Gode says. He points to Apple Inc. as a cash-rich company with relatively little debt. “And then there are plenty that have huge levels of debt,” including some energy companies and hospitals.

Mr. Constable is a writer in New York. He can be reached at reports@wsj.com.

Downgrade: Miami Municipal Bonds (Miami Herald)

Posted on Thu, Jun. 17, 2010
Standard & Poor's downgrades Miami bond rating by two notches
BY PATRICIA MAZZEI
pmazzei@MiamiHerald.com

A key agency has downgraded cash-strapped Miami's bond credit rating, a shift that will leave the public footing a higher bill for big-ticket projects, including parking garages for the new Marlins ballpark.
Standard & Poor's Ratings Services dropped two of the city's critical bond credit ratings by two notches, making it more expensive for Miami to borrow money at a time the city is scrambling to keep its budget afloat.
``That will have a significant impact on the cost of projects,'' said Tom Tew, a Miami securities attorney who has represented the city in the past. ``This is just another straw on the camel's back.''

Standard & Poor's lowered the rating for general obligation bonds -- usually backed by property taxes -- from A+ to A-, and the rating for bonds backed by other revenues from A to BBB+. The rating agency cited the city's climbing employee pension costs and unwillingness to raise taxes as reasons for its negative credit outlook.

``They have skepticism of the ability of the city to reduce expenses,'' City Manager Carlos Migoya said Thursday.

``I feel very confident that we'll be able to do that,'' he added -- possibly through employee union negotiations or layoffs.

The most immediate fallout: Funding for the city to build surface parking lots and four garages at the Marlins' new home in Little Havana.

Miami plans to float $104 million in bonds next month to finance the garages. Because of the lower bond rating, it will cost the city $15 million more to pay off those bonds over the next 30 years, the city manager estimated.

Migoya said that is about $15 million less than the garages would have cost over three decades if the city were building during boom times with higher construction prices.

The bonds will be paid off with money from a variety of sources, including a convention development tax generated by hotel sales and the average $10 the Marlins will pay the city to buy almost all of the parking spaces.

The manager said the credit downgrade should not delay construction. Work began this month after the city borrowed $3 million from a capital fund and received a $20 million bridge loan. The Marlins hope to begin play at the new ballpark on Opening Day in April 2012.

The rating downgrade is the latest dark financial cloud over the city.

Two months ago, another agency, Moody's Investors Service, shifted the city's credit outlook from a stable to a negative position, an indication that Miami's bond rating was poised to take a hit.

Miami leaders have had to raid the city's reserves to plug budget holes, including using $54 million from the rainy-day fund earlier this year to balance the 2009 budget.

The U.S. Securities and Exchange Commission continues to scrutinize whether the city hid its financial troubles from investors over the past three years, a review with potentially far-reaching budget implications.

Last week, city leaders discussed a controversial doomsday scenario: laying off more than 1,100 employees to fill a $100 million budget hole. Commissioners have sounded wary of raising taxes to cover the shortfall.

Against this backdrop, credit agencies are under pressure across the country to redo municipal bond ratings as home sales and property taxes -- local governments' main source of revenue -- tumble in the slumping economy.

Standard & Poor's noted Miami's historical difficulty with cutting expenses, and said cutbacks probably would not be enough without structural changes to labor contracts.

``The city's financial flexibility has been greatly reduced by growing fixed costs and limited tax-raising flexibility and willingness,'' the agency's report said, adding that the absence of ``considerable expenditure reductions could lead to further credit deterioration.''


Read more: http://www.miamiherald.com/2010/06/17/v-print/1687104/standard-poors-downgrades-miami.html#ixzz0rGPlYEtM

BP and Bankruptcy (NY Times)

June 7, 2010
Imagining the Worst in BP’s Future
By ANDREW ROSS SORKIN

It seems unthinkable, even now, that the disastrous oil spill in the Gulf of Mexico could bring down the mighty BP. But investment bankers get paid to think the unthinkable — and that is just what they are doing.

The idea that BP might one day file for bankruptcy, particularly as part of a merger that would enable it to cordon off its liabilities from the spill, is starting to percolate on Wall Street. Bankers and lawyers are already sizing up potential deals (and counting their potential fees).

Given the plunge in BP’s share price — the company has lost more than a third of its value since Deepwater Horizon blew — some bankers and analysts say BP is starting to look like takeover bait. The question is, who would buy BP, given its enormous potential liabilities?

Shell and Exxon Mobil are both said to be licking their chops. And already, flinty legal minds are dreaming up scenarios in which BP would file a prepackaged bankruptcy and separate the costs of the cleanup — and potentially billions of dollars in legal claims — into a separate corporate entity.

Tony Hayward, BP’s chief executive, has insisted that his giant will weather this storm. BP is indeed a money machine: it turned a profit of nearly $17 billion last year.
“The strength of cash-flow generation in recent quarters has provided us with a balance sheet that allows us to fully take on the responsibility for the Gulf of Mexico response,” Mr. Hayward told employees last Friday.

But that hasn’t stopped the deal crowd from blue-skying potential outcomes. Here is some of the math:

BP’s costs for the cleanup could run as high as $23 billion, according to Credit Suisse. On top of that, BP could face an additional $14 billion in claims from gulf fisherman and the tourism industry. So while conservative estimates put the bill at $15 billion, something approaching $40 billion is not out of the question. After all, little about this spill has turned out as expected.

The company has about $12 billion in cash and short-term investments, but there is already a debate about whether it should cut its dividend out of fear that it could run out of money. Of course, it could sell assets or seek loans, which in this environment is still not that easy.

But all those numbers don’t account for the greatest possible threat: a jury verdict against BP. Such a verdict might push the cost of the spill into the hundreds of billions. If that happened, even BP might buckle.

This outcome might seem far-fetched right now. But on Wall Street bankers have already coined a term for it: “the Texaco scenario.”

In 1987, Texaco was forced to file for Chapter 11 because it could not afford to pay a jury award worth $1 billion to Pennzoil. That award had been knocked down by a judge from a whopping $10.53 billion. (Pennzoil successfully sued Texaco for “jumping” its planned merger with Getty Oil, in part, by moving the case to local court near its headquarters. The jury awarded triple damages.)

Imagine the BP case playing out in a Louisiana courtroom, against the backdrop of an oil-choked local economy, high unemployment and an angry public. How high can you count?

Under the Oil Pollution Act of 1990, BP’s liability for economic devastation — above the cost of the cleanup — is capped at $75 million, a number Mr. Hayward has already said he plans to blow through. But if BP is found to have violated safety regulations, which seems likely, that cap becomes irrelevant.

That’s not to say that BP won’t fight a huge judgment against it. After the Exxon Valdez spill, Exxon fought a $5 billion fine for punitive damages for two decades. It won. The fine was cut down to $4 billion, then to $2.5 billion. The case eventually made it to the Supreme Court, which found that Exxon’s actions were “worse than negligent but less than malicious,” and vacated the fine. The judgment limited punitive damages to the compensatory damages, which were calculated as $507.5 million.

“There are so many imponderables over whether its liabilities would be capped or not,” David Buik of BGC Partners in London wrote of BP. “If BP’s share price continues to fall, it could become a takeover target.”

Given that Shell and Exxon have billions in cash on hand and market values that easily exceed BP — Exxon is twice the size — bankers say now is the time to make a deal, as long as an acquirer can find a way to separate the legal exposure. That, of course, is a big ‘if.’

There are many people — besides BP — who think even discussing the possibility of a bankruptcy or takeover is silly. But looking out a few years, that may be BP’s best, last hope.

“Even with a prepackaged bankruptcy, BP’s brand is permanently tainted,” said Robert Bryce, a senior fellow at the Manhattan Institute and author of “Power Hungry: The Myths of ‘Green’ Energy and the Real Fuels of the Future.” Yes, BP is financially sound now. It is unlikely to go bust near term, he said.

“Instead, BP will spend the coming decades circling the drain, mired in endless litigation, its reputation irreparably damaged, and its finances weakened,” Mr. Bryce said.

That, if you believe the bankers, is the optimistic outcome.


The latest news on mergers and acquisitions can be found at nytimes.com/dealbook.

What Ever Happened to Eastern Financial Credit Union (NYTimes)

May 14, 2010
A Credit Union That Played With Fire
By GRETCHEN MORGENSON

WHEN Wall Street is accused — as it has been so often these days — of selling risky products to unwitting customers, it usually argues that investors in such exotic stuff are sophisticated adults capable of assessing any hidden dangers.

So it goes with collateralized debt obligations, or C.D.O.’s, which are bonds, loans and other assets that the Street pools together and sells as packages of securities. Purveyors of C.D.O.’s maintain that buyers who lost billions in these mortgage-related instruments were, of course, sophisticated.

But as a recent report from the inspector general of the National Credit Union Administration shows, it is neither credible nor factual that only savvy investors bought C.D.O.’s.
The report analyzes the April 2009 collapse of the Eastern Financial Florida Credit Union. Based in Miramar, Fla., this state-chartered institution was created in 1937 to serve the Miami employees of what later became Eastern Airlines. The institution added other Florida employee groups and was serving 208,000 members when it failed last year.
Eastern Financial had $1.6 billion in assets at the end of 2008. The company was placed in conservatorship on April 24, 2009. It was taken over by the Space Coast Credit Union of Melbourne, Fla. The failure will cost the National Credit Union Share Insurance Fund, the federal agency that guarantees credit union deposits, an estimated $40 million.

Because it was based in Florida, the doomed credit union had its share of bad real estate loans on its books. But the inspector general’s autopsy report said that the major cause of the Eastern Financial collapse was its decision to dive head-first into toxic C.D.O.’s just as the mortgage mania was faltering.

Between March 2007 and June 22, 2007, the credit union committed nearly $100 million to buy 16 of these instruments; most contained dicey home equity loans.

The timing of these purchases is intriguing. The spring of 2007 was when Wall Street’s mortgage machinery was sputtering; New Century Financial, a big subprime lender, filed for bankruptcy that April. Brokerage firms that had provided funding to lenders like New Century and Countrywide began pulling in their credit lines. At the same time, it became a matter of some urgency for these firms to jettison mortgage-related securities in their pipelines.

Who sold Eastern Financial its toxic securities? Alas, the inspector general identifies neither the C.D.O.’s the credit union bought nor the firms that peddled them.

But the report did note that the instruments Eastern Financial bought were private placements, “which provided less readily available market data to perform analysis and provide better understanding of underlying assets and grading system, tranches, etc.” In other words, the most obscure C.D.O.’s imaginable.

“This situation illustrates yet again why over-the-counter securities and derivatives are not suitable for federally insured banks and other ‘soft’ institutional clients,” said Christopher Whalen, editor of The Institutional Risk Analyst. “Wall Street securities dealers who knowingly cause losses to federally insured depositories should go to jail.”

Credit unions are nonprofit entities and typically do not engage in the risky investing that bank executives did during the credit bubble. Federal credit unions are also limited in the types of securities they can buy. While they can purchase mortgage-backed securities, they are barred from buying C.D.O.’s.

State-chartered credit unions have more leeway to invest in exotic instruments if their home states allow it. Florida, California and Michigan are three such states. But according to the National Credit Union Administration, less than 1 percent of all credit union investments fall into the exotic category.
THOSE state-chartered institutions that can buy C.D.O.’s and other riskier investments must set aside reserves of 100 percent of mark-to-market losses in such securities when they decline in value. This is intended to deter credit union executives from venturing down the risk spectrum.

The Florida credit union met that requirement, but clearly the deterrence didn’t work. Eastern Financial’s failure may be an outlier, but it makes for a terrific case study.

Indeed, the inspector general’s analysis is depressingly familiar. Eastern Financial’s management and board “relied too heavily on rating agencies’ grading of C.D.O. investments,” it concluded, and failed to evaluate and understand their complexity.

Almost immediately after the credit union bought the C.D.O.’s, they fell in value. By September 2007, the credit union had recorded $63.4 million in losses on the products, almost two-thirds of the original investment. By the time of its failure, the credit union had charged off all 18 C.D.O. investments, resulting in total losses of nearly $150 million.

Richard Field, managing director of TYI, which develops transparency, trading and risk management information systems, says the Eastern Financial collapse is yet another example of why investors in complex mortgage securities need to be able to consult complete loan-level data on what is in these pools.

“A sizable percentage of the problems in the credit markets and bank solvency are directly related to this lack of information,” Mr. Field said.

But the Eastern Financial insolvency also illustrates why regulators should make Wall Street adhere to concepts of suitability for institutions as well as individuals, Mr. Whalen said.

“The dealers who sold the C.D.O.’s to this credit union should be sanctioned,” he said. “It might even be possible to pursue the dealer who sold the C.D.O.’s under current law. At a minimum, the Securities and Exchange Commission should impose retail investor suitability standards onto banks and public sector agencies to end the predation by large Wall Street derivatives dealers.”

Will the National Credit Union Administration pursue any of the credit union’s executives or the firms that sold it the toxic securities? “We always consider potential claims of third-party liability in cases of this magnitude," said John J. McKechnie III, director of public and congressional affairs at the administration.

Ford: Good Response from Debt Buyback, Debt Downgraded (Bloomberg)

Ford Reduces Debt 38% With Buybacks of Bonds, Loans (Update3)


By Keith Naughton and Caroline Salas

April 6 (Bloomberg) -- Ford Motor Co., slashing costs to stay off government aid, said it trimmed $9.9 billion of borrowings as the company completed its largest debt restructuring.

The transactions, which reduce automotive debt by 8 percent, will “substantially strengthen Ford’s balance sheet,” the second-biggest U.S. automaker said today in a statement. Ford had sought to erase as much as $11.3 billion in notes and loans in a three-pronged effort. The company’s shares rose to their highest close in six months.

“It gives them more time, and the timing was really good because it would be a lot more difficult if they borrowed money from the government,” said Mirko Mikelic, senior portfolio manager at Fifth Third Asset Management in Grand Rapids, Michigan, which holds Ford bonds. “It’s always a great move when you can buy back your debt at 30 cents on the dollar.”

Ford on March 4 offered investors the chance to accept discounted payouts for the notes and loans, trimming debt costs as the automaker tries to stem losses that totaled $30 billion in the past three years. The Dearborn, Michigan-based company has avoided U.S. assistance, while General Motors Corp. and Chrysler LLC survive on $17.4 billion in federal loans.

The company, which lost a record $14.7 billion last year, said it will save more than $500 million in annual interest costs. The automaker and its Ford Motor Credit Co. finance unit will use $2.4 billion in cash and 468 million Ford Motor shares to repurchase the debt. The shares are valued at $1.76 billion based on today’s closing price.

Shares Rise

Ford rose 52 cents, or 16 percent, to $3.77 at 4:15 p.m. in New York Stock Exchange composite trading, the highest close since Oct. 3. The shares have gained 64 percent this year.

The automaker has enough liquidity left to remain self- sufficient and not seek government aid, Treasurer Neil Schloss said in an interview.

Should the U.S. auto market, which is at a 27-year-low, not recover, Ford is better shape to seek government aid, JPMorgan auto analyst Himanshu Patel in New York said in a research note.

“The exchange could be aimed in part at mollifying the concerns of various stakeholders and a possible precursor to eventual government aid,” said Patel, who has a “neutral” rating on Ford shares. “Ford has now accomplished a fair amount of what was asked of GM and Chrysler.”

Schloss said the debt restructuring “met all our expectations.” Shelly Lombard, an analyst for bond researcher Gimme Credit in New York, said he had expected more than $11 billion in debt to be retired.

Rating Lowered
Standard & Poor’s cut Ford’s corporate credit rating today to SD, or selective default, and said it would assign a new rating by mid-April based on the automaker’s balance sheet and business prospects. S&P said the new rating will likely not be higher than about CCC, or 8 grades below investment status. The previous rating was CC, or 10 steps into junk.
Fitch Ratings said the debt transaction are a “positive step in managing the company’s liability structure” and left Ford’s ratings unchanged. Fitch and Lombard at Gimme Credit said they were concerned that Ford access to funds is declining.

“With poor operating results now expected through 2009, Ford’s liquidity is becoming strained,” Lombard wrote today in a note. “Although Ford’s future still depends on a recovery in auto sales, the debt restructuring and union contract changes have decreased the chances of a Ford bankruptcy.”

Notes Rise

The automaker’s $579 million of 4.25 percent convertible notes due in 2036 gained 6 cents to 46.5 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The securities yield about 10 percent.

Ford Credit’s $3.5 billion of 7.25 percent notes due in 2011 were unchanged at 72 cents on the dollar, according to Trace. They yield 22.2 percent, or 21.3 percentage points more than similar-maturity Treasuries.

The automaker’s bonds gained 36.6 percent in March after Ford asked investors to swap their debt, according to index data compiled by Merrill Lynch & Co. That compares with a 1.9 percent return for GM securities, Merrill data show.
The automaker, which consumed $21.2 billion in cash last year, is tapping some of its available funds to finance the buybacks. Ford is using $344 million of its $13.4 billion in automotive cash, Schloss said. Ford Credit is spending $2.1 billion of its $18 billion in funds, he said.

‘Decisive Actions’

“Ford continues to lead the industry in taking the decisive actions necessary to weather the current downturn,” Chief Executive Officer Alan Mulally said in a statement.

The final phase of Ford’s offer, which ended April 3, included a cash-and-stock proposal valued at about 28 cents on the dollar to induce holders of $4.9 billion in convertible bonds to trade for the company’s common shares. Bondholders claimed $4.3 billion of that proposal, an 88 percent take rate that the company considered oversubscribed, Schloss said.

Ford also offered to spend $1.3 billion to buy back unsecured non-convertible debt. Holders claimed $1.1 billion of that amount, retiring $3.4 billion in debt, the company said.

Ford on March 23 also said an offer to repurchase its term loans was oversubscribed, prompting the company’s finance arm to double to $1 billion the cash it planned spend on the so-called Dutch auction. Ford said today that it will buy $2.2 billion of the principal amount of the debt, at 47 percent of face value.

The automaker had $25.8 billion of debt at the end of 2008 after borrowing $23.4 billion in late 2006, giving it more cash than GM or Chrysler. As collateral for that financing, Ford put up all major assets, including its headquarters and blue oval logo.

U.S. automakers are struggling after industry sales of cars and light trucks fell to a 16-year low in 2008 and declined 38 percent in this year’s first three months. Ford’s U.S. sales fell 41 percent in March.

To contact the reporter on this story: Keith Naughton in Southfield, Michigan at Knaughton3@bloomberg.net; Caroline Salas in New York at csalas1@bloomberg.net

Last Updated: April 6, 2009 16:34 EDT