If history is any guide, Moody's Investors Service's recent downgrade of Levi Strauss & Co.'s $1.6 billion in senior unsecured notes to a rating of Ca may signal that the bonds of the privately held clothing manufacturer are on the verge of default. Moody's rating is a full five notches lower than the B rating given the same credit by Standard & Poor's, a difference that is highly unusual. Catherine Guinee, the lead analyst behind Moody's recent four-notch blow to Levi, has a clear track record when it comes to alerting investors to potential defaults in the textile and apparel industries.
Guinee was the lead analyst on at least five previous occasions when Moody's dropped an issuer into the dreaded triple-C category ahead of S&P. All five issuers eventually defaulted. In two of those instances--downgrades of Galey & Lord and Westpoint Stevens--Moody's took the credits to triple-C two years before they defaulted. The other companies were Warnaco Inc., Pillowtex Corp. and Polymer Group.
"There will always be occasions where the ratings agencies have different opinions. The bottom line is that our ratings work; they are excellent predictors of default across all rating categories and we have studies to prove it," says Nicholas Riccio, S&P managing director.
Linda Butler, a Levi spokeswoman, claims Moody's rating is too severe. Generally, the market perceives a triple-C rating to mean that a default will happen within one year. Moody's definition, however, places no time horizon on a potential default, according toPatrick Finnegan, a Moody's managing director. Finnegan stresses that Moody's ratings reflect not merely when a default is likely to occur, but what investors' recoveries are likely to be on a particular bond or security.
Guinee stresses that she does not personally assign ratings to a company. "I'm responsible as a senior analyst to prepare the analysis. It's scrutinized and debated for a couple of hours, and then there's a vote by a committee. I can be outvoted," she says. The agency has a policy of not disclosing the members of a committee or their individual votes, according to Finnegan.
One sell-side analyst estimates that Levi's 121Ž4% notes of '12 would be worth roughly 70 in a default scenario. They were bid at 84.5 last Thursday, after the company announced a new round of layoffs and plant closings. The bonds have dropped some 10 points since the company's Sept. 10 announcement that it would require a temporary waiver of covenants under an existing bank facility, and would seek a new facility that would potentially put $300 million ahead of the outstanding bonds. Credit Suisse First Boston promptly downgraded the bonds to "underperform," while Goldman Sachs and Bear Stearns dropped their recommendations to "hold" from "buy," respectively. Carla Casella, analyst at J.P. Morgan Securities, maintained her overweight, and argues that the 12 1/4% notes should trade in the 90s.
