Junk borrowers ward off bankruptcy

(breakingviews.com) -- Junk borrowers are trading death row for long jail time.

Resurgent debt markets have helped several high-yield borrowers refinance loans. That will keep them from defaulting when loans come due, averting the possibility of death by bankruptcy.

But with interest costs most likely at least doubling, their cash flows will be squeezed, as Breakingviews.com's calculator shows -- condemning some to protracted penny-pinching, if not worse.

Blockbuster (BBI, Fortune 500), MGM Mirage (MGM, Fortune 500), Dole Food, Del Monte (DLM), Frontier Communications (FTR), and Ford Motor Credit (FCZ) have all sold new debt in the past week or so. Some are using the proceeds specifically to repay loans, others to refinance bonds or more generically to pay down other debt.

Refinancing debt that would otherwise soon need repayment removes, or at least defers, a potential worry. But these deals aren't unalloyed good news, because they don't always come cheap.

MGM Mirage, for example, issued notes carrying a fixed 11.375% interest rate to pay down floating-rate bank loans that had an average interest rate of 3.4% last year.

This kind of huge step up in debt service costs could be crippling.

Consider the imaginary XYZ Corp. Two years ago, it completed an LBO with debt at six times its $100 million of earnings before interest, tax, depreciation, and amortization. Because banks were lending freely, the company had $450 million of loans, with an average interest rate of 5% annually. The rest of the debt consisted of bonds with an 8% coupon. The company paid annual interest of around $35 million.

The loans would have been due in a year or two. Happily for XYZ, it has managed to sell new bonds to refinance them. The new debt has an interest rate of 11.5%. Combined with the continuing interest due on the old $150 million batch of bonds, the company's annual interest expense nearly doubles. And nearly two-thirds of its EBITDA is now eaten up by interest, against one-third before -- even making the generous assumption that EBITDA has been unaffected by the recession.

So companies that have refinanced in this way are now in a position where they will have less cash than before to invest in their businesses, and less cushion against rough periods.

Sure, they may have spared themselves default by refinancing loans. But they are far from home free.