00:00:07: Welcome to episode thirty-six of EFZ Talking Finance.

00:00:14: This edition features a special AI-generated summary produced with Notebook LM distilling Moody's latest analysis on speculative grade credit into a listener-friendly audio format.

00:00:29: The episode titled, Week Liquidity Ways on Credit Quality More Than Good Liquidity Supports It, unpacks the critical insights from Moody's guest article in the Founding and Treasury Study, twenty-twenty-five.

00:00:44: For lower-rated issuers, liquidity strengths and cash flow visibility met

00:00:49: more

00:00:50: for credit quality than leverage metrics alone.

00:00:53: Based on the July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July, July.

00:01:12: This content is highly relevant for CFOs, group treasures and credit analysts seeking to understand how rating agencies weigh liquidity, refinancing risk and free cash flow sustainability in the current cycle.

00:01:26: In a market where refinancing windows can close abruptly, the ability to generate steady operating cash flow and maintain flexible liquidity buffers has become the true differentiator between stability and downgrade risk.

00:01:44: Tune in for a focused intelligence brief on what drives corporate credit resilience today, why treasures should rethink liquidity strategies beyond leverage ratio.

00:01:59: Welcome to the deep dive.

00:02:01: We are going straight into the heart of corporate risk management today, our mission.

00:02:06: to really unpack how credit quality gets assessed way down at the risky end of the spectrum.

00:02:11: We're talking speculative-grade companies, you know, the ones often linked with junk bonds, and we've been digging through quite a bit of proprietary research, and honestly, the findings challenge a pretty core assumption many investors make.

00:02:22: What we found is that when you're looking at these lower-rated issuers, think B-threes, CAST-I's liquidity, which is, you know, immediate cash flow in reserves, often sends a stronger signal about immediate default risk than the traditional stuff, like leverage ratios.

00:02:35: how much debt they actually carry.

00:02:36: Yeah, it's one of the real paradoxes you see in low-end credit analysis.

00:02:41: I mean, when a company is really teetering, the fact that it's dead as high is almost secondary.

00:02:46: What matters right now is whether it can pay its next bill.

00:02:49: For companies rated B-three or K-one, weak liquidity isn't just like a minor concern.

00:02:54: It is the single most common precursor to either a non-payment default or, you know, one of those distress debt exchanges.

00:03:02: If that cash window slam shut, the game is pretty much over.

00:03:06: Now, it is important to differentiate here.

00:03:07: If you move up the ladder a bit in speculative grade, say, to the Bay rating, well, adequate liquidity is kind of expected, it's table stakes.

00:03:14: Having a huge cash pile doesn't necessarily boost a Bay rating much further, but down at the bottom, B three and below, the absence of decent liquidity, that's often the trigger for a downgrade, or worse.

00:03:25: The rating agency approach really recognizes that survival, especially in that volatile space, is often a cash flow problem first and maybe a debt problem second.

00:03:34: Okay, yeah, that makes sense, conceptual.

00:03:35: survive needs cash, obviously.

00:03:37: But let's untack what liquidity truly means here, because just glancing at the cash line on a balance sheet, that's clearly not enough, right?

00:03:44: Exactly.

00:03:44: What are the rating agencies actually looking at when they put companies into these boxes, weak, adequate, good, or very good, liquidity?

00:03:52: Right.

00:03:53: It's a pretty holistic assessment, and it's forward-looking, usually looking out, say, the next twelve months.

00:03:59: What they're really looking for is the certainty of funding.

00:04:01: And the analysis usually breaks down into four main components.

00:04:05: Okay.

00:04:05: First is internal sources.

00:04:07: This one's pretty straightforward.

00:04:10: How much cash does the company actually have right now and what's its expected free cash flow generation look like?

00:04:16: Can they cover all their operating costs and mandatory debt payments just with the money they make themselves?

00:04:22: Second is external sources.

00:04:24: This is about how much they rely on say committed bank facilities like revolving credit lines or RCFs and crucially the size and the certainty of those commitments.

00:04:35: Are these reliable banks?

00:04:36: Are the lines truly available?

00:04:38: Okay, so how solid is that backup plan?

00:04:40: Precisely.

00:04:42: Third, and this one is really critical, is covenant compliance.

00:04:45: You know, a loan commitment is only useful if you can actually draw on it.

00:04:49: So analysts look really hard at the cushion the company has before it might trip a loan covenant, like a leverage covenant or interest coverage.

00:04:57: If they're getting close to breaching one of those metrics, that external liquidity could just poof, vanish overnight.

00:05:03: Ah, so the conditions attached matter hugely.

00:05:05: Absolutely.

00:05:06: And then finally, there's alternate liquidity.

00:05:08: Basically, do they have a plan B?

00:05:11: This could be things like unencumbered assets, assets without lekinins that could be sold pretty quickly or maybe used as collateral to get some emergency financing.

00:05:19: Okay, so based on those four things, they get put in a category.

00:05:23: You mentioned the extremes earlier.

00:05:24: What's the real difference between, say, very good

00:05:27: and weak?

00:05:28: Yeah, think about the two ends of the spectrum.

00:05:30: If a company gets a very good liquidity rating, it basically means they are highly likely to meet all their obligations over the next year using only their internal cash and the cash flow they generate, without even needing to touch their bank lines.

00:05:43: That shows real resilience.

00:05:44: Right, self-sufficient.

00:05:45: Exactly.

00:05:47: Now contrast that with weak liquidity.

00:05:49: That classification means the company is actually relying on external financing just to cover mandatory payments like interest or upcoming debt maturities.

00:05:58: And, crucially, the availability of that external financing is considered highly uncertain.

00:06:03: Maybe the RCF is too small or maybe, and this is common, they're sailing really close to the wind on their covenants.

00:06:10: So weak means you are basically one bad quarter away from a potential crisis.

00:06:15: That's a good way to put it, the certainty just isn't there.

00:06:17: That distinction, certainty versus uncertainty, that feels like the key market signal we need to hone in on.

00:06:24: Let's look at some of that proprietary data you mentioned from July, twenty twenty five.

00:06:29: It compares B three and K one rated issuers globally.

00:06:32: The difference is pretty stark, isn't it?

00:06:34: It really is staggering.

00:06:36: If you look at the B-three issuers around the world, only about five percent of them had a weak liquidity assessment.

00:06:43: Only five

00:06:44: percent.

00:06:44: Yeah.

00:06:45: So that tells you, even though they're low-rated, often pretty indebted, the vast majority, ninety-five percent, have basically sorted out their short-term funding needs for the next year or so.

00:06:56: Okay.

00:06:56: Now, Cal One.

00:06:58: Now, look at Cal One.

00:06:58: It's a completely different story.

00:07:00: Yeah.

00:07:00: A massive Thirty seven percent of cow one issuers globally had a weak equidity assessment.

00:07:07: Well,

00:07:07: thirty seven percent.

00:07:08: That's huge.

00:07:09: It's an enormous slice of that rating category just operating without a reliable safety net.

00:07:14: It's what almost eight times the rate you see in the B three category.

00:07:17: Thirty

00:07:17: seven percent.

00:07:18: That just screams.

00:07:19: Danger zone.

00:07:20: That feels like a flashing red light for future default rates, doesn't it?

00:07:23: It absolutely does.

00:07:24: And you can flip the comparison too.

00:07:25: Look at the positive side.

00:07:26: Okay.

00:07:27: Only nine percent of those K-one issuers had good liquidity or better.

00:07:30: Just nine percent felt truly comfortable from a cash perspective.

00:07:34: Meanwhile, for the B-three issuers, thirty-eight percent had good liquidity or better.

00:07:38: Thirty-eight percent.

00:07:39: Much healthier.

00:07:40: Much healthier.

00:07:41: It strongly suggests that liquidity acts as this immediate firewall.

00:07:46: You know if your underlying business is maybe a bit weak, but you've got the cash buffer.

00:07:51: You might hold on to that B three rating stability wise But if you don't have that cash buffer you risk plummeting into that care one danger zone pretty quickly.

00:07:59: Okay, so this is where the findings get really interesting right where you see liquidity sometimes just Completely overriding the traditional alarm bell of high debt.

00:08:08: This is what you call the leverage illusion.

00:08:11: the source is compared to pretty counterintuitive groups, using seven times debt to EBITDA as the dividing line for high leverage.

00:08:18: Exactly.

00:08:19: We're basically comparing companies with seemingly manageable debt levels that are failing versus companies with objectively high debt that are somehow surviving, for now at least.

00:08:28: Right.

00:08:29: So first, let's look at the KON issuers who actually had lower leverage.

00:08:33: Their debt to EBITDA was below seven X. You might think, okay, their debt's not crazy high, maybe they're relatively safe.

00:08:39: Yeah, that's the logical assumption.

00:08:40: But nope.

00:08:41: Forty-eight percent almost half of that low liver K-O-one group still ended up with a weak liquidity assessment.

00:08:47: Forty-eight percent.

00:08:48: Yeah, even with lower debt

00:08:49: even with lower debt and only about seven percent of them managed to get good liquidity.

00:08:55: So their debt metrics might have looked okay on paper, maybe even manageable But they were effectively insolvent in the short term because they just couldn't fund their day-to-day operations or meet upcoming maturities.

00:09:07: The cash wasn't there.

00:09:08: So that low leverage number was totally misleading in predicting immediate risk.

00:09:12: They were functionally distressed anyway.

00:09:14: Absolutely.

00:09:15: Now, let's flip it.

00:09:16: Let's look at the B three issuer who had higher leverage debt above that seven mic EBITDA threshold.

00:09:22: This is the kind of debt level that usually makes investors really nervous.

00:09:26: Yeah, seven X plus is definitely high yield territory headache.

00:09:30: It is.

00:09:30: But despite this massive debt load, only two percent, just two percent of this high lever B three group had a weak liquidity assessment.

00:09:37: Only two percent.

00:09:38: That's incredible.

00:09:39: Incredible.

00:09:40: And even better, more than forty percent of them scored good or better on liquidity.

00:09:44: Hold on.

00:09:44: Let me get this straight.

00:09:45: Forty percent of the high levered B three companies were demonstrably safer from an immediate survival perspective than the low levered K one companies.

00:09:54: That's exactly what the data shows.

00:09:56: That completely turns the traditional view on its head.

00:10:00: Why isn't the market panicking more about those B threes lugging around seven X or more debt?

00:10:05: Well, because that high leverage while definitely a long term risk that needs managing isn't necessarily an immediate survival threat for them.

00:10:14: Their liquidity.

00:10:15: the certainty of their near-term cash flow, their access to those committed bank lines, it gives them a runway, sometimes a surprisingly long runway.

00:10:24: The rating agencies are sort of implicitly saying, okay, yes, you've got way too much debt on the books, but you also have, say, eighteen months of guaranteed operational funding to figure it out.

00:10:34: Meanwhile, those K-O-O ones, even the ones with lower debt, might only have, you know, three or maybe six months of funding certainty left before they hit a wall.

00:10:42: That makes the distinction crystal clear.

00:10:44: The rating, especially down there, is really driven by the ability to survive the next year, not necessarily the absolute optimal dead structure five years out.

00:10:53: Precisely.

00:10:54: And we can actually see this playing out with a couple of real-world examples.

00:10:57: Two European speculative grade issuers, Olympic and Pensani, they illustrate this perfectly.

00:11:03: Okay,

00:11:03: let's dig into those.

00:11:04: Let's start with the cautionary tale, maybe.

00:11:06: Olympic.

00:11:07: the online gaming operator.

00:11:08: They were rated Kaia-one negative.

00:11:11: What did their debt picture look like?

00:11:12: Right.

00:11:12: So, Olympic, their leverage, looking at the numbers from December, twenty-twenty-four, was actually relatively low for the sector, just five point zero.

00:11:20: X debt bidda.

00:11:21: Five times.

00:11:22: Objectively, you'd think that might put them higher, maybe a Sable B three.

00:11:26: You would think so based on leverage alone.

00:11:29: However, the absolute core issue for them was pure liquidity risk.

00:11:33: They had some operational underperformance, particularly in their land-based casinos, and that really hammered their free cash flow generation.

00:11:40: Their internal cash reserves just weren't going to be enough to meet a really critical upcoming payment.

00:11:45: A EUR, two hundred million bond maturity due in December, twenty twenty-five.

00:11:50: Okay,

00:11:50: a big cliff edge coming

00:11:51: up.

00:11:52: a very big cliff edge.

00:11:53: They couldn't fund it internally and crucially they couldn't guarantee they'd be able to access the external markets to refinance it given their performance.

00:12:01: So this refinancing risk driven entirely by that immediate cash shortfall was basically the sole reason for that very low K-one rating, despite the moderate leverage.

00:12:11: Wouldn't okay on the leverage metric, but couldn't actually find the cash to pay the upcoming bill.

00:12:15: Right.

00:12:15: Classic liquidity crunch.

00:12:17: Exactly.

00:12:18: Now, contrast that with the French food maker, Panzani, they were rated B-three stable.

00:12:24: Okay, Panzani.

00:12:25: B-three stable.

00:12:26: Pansani is almost the poster child for this whole leverage illusion concept.

00:12:30: Their leverage was exceptionally high.

00:12:32: It peaked at a massive nine point zero X debt a bit in December,

00:12:37: twenty

00:12:39: twenty four nine times.

00:12:39: And this was largely because they did a dividend recapitalization.

00:12:42: Basically, the company intentionally took on a bunch of new debt just so it could pay out a large cash dividend to its private equity owners.

00:12:49: Right.

00:12:49: Loading up the company with debt to pay the owners nine times sounds like a ticking time bomb.

00:12:54: Isn't that kind of debt structure usually seen as a huge red flag?

00:12:57: How on earth does a rating agency justify keeping them at B-three stable with that kind of number?

00:13:03: It's a fair question.

00:13:04: It's justified almost entirely by their exceptional and, importantly, very stable liquidity position.

00:13:10: The liquidity again?

00:13:11: The liquidity again.

00:13:12: Pensani sells staple food products, pasta, sauces, that sort of thing.

00:13:16: Stuff people buy regardless of the economy.

00:13:18: So they have very stable demand and highly predictable cash flow.

00:13:22: They just don't need a massive buffer against, say, cyclical downturns like some other industries

00:13:27: do.

00:13:27: Okay, stable business helps.

00:13:29: Yeah.

00:13:29: But the numbers?

00:13:30: More importantly, their actual liquidity numbers were fant-.

00:13:33: As of that same period, they held EUR hundred and sixty five million in cash on their balance sheet.

00:13:39: Okay.

00:13:39: And they also had access to a fully committed EUR seventy million revolving credit facility, RCF.

00:13:46: So add those up.

00:13:46: That's EUR two hundred thirty five million of guaranteed certain available liquidity.

00:13:52: Now compare that to their twenty twenty four EBITDA, which was around EUR seventy three million.

00:13:57: That liquidity buffer is more than three times their annual earnings.

00:14:00: Regents earnings just sitting there available.

00:14:02: Exactly.

00:14:03: That incredibly robust liquidity is what supports the B-III stable rating.

00:14:07: It gives management a really long runway easily a year, probably more, to just operate the business smoothly and figure out a strategy to gradually bring down that nine X debt load over time.

00:14:18: So, Olympic failed because of immediate cash flow uncertainty even with only five X debt.

00:14:22: Benzani survives and gets a stable rating because of the certainty of its massive cash buffer even while carrying nine X debt.

00:14:29: It really hammers home the point.

00:14:31: Down to the bottom end of the credit spectrum, it's access to oxygen, the cash, not necessarily how heavy your backpack, the debt, that defines whether you survive the next climb.

00:14:42: Okay, let's transition a bit.

00:14:45: As we hinted at earlier, this almost obsessive focus on near-term liquidity doesn't necessarily apply quite the same way as you move up the credit scale.

00:14:54: What changes when we look at, say, higher speculative grade companies?

00:14:58: like Bay two and B three issuers.

00:15:00: Right.

00:15:00: Well, at those Bay ratings, the intense focus on just liquidity tends to diminish somewhat.

00:15:05: And that's largely because almost by definition, most companies rated Bay already have adequate or better liquidity.

00:15:11: If they didn't, they probably wouldn't be rated bow in the first place.

00:15:14: If you look at the distribution of liquidity assessments across Bay two and Bay three rated companies, it's not substantially different between the two.

00:15:21: Most are adequate or good, weak is rare.

00:15:23: So adequate liquidity is kind of assumed at that level.

00:15:26: It's largely assumed, yes, at that point, the market and the rating agencies tend to shift their focus back towards more longer term structural factors that determine credit quality over time, things like the inherent strength of the company's actual business profile, its market position, its competitive advantages, also the overall industry and economic environment they operate in, and really importantly, their long term financial policy, you know, is management committed to reducing debt over time, or do they have a history of, say, leveraging up for acquisitions or shareholder returns like Pensani did, but maybe without Pensani's liquidity buffer?

00:16:04: So bigger picture stuff comes back into play.

00:16:07: Exactly.

00:16:08: Those factors tend to dictate the rating stability over a period of years, not just the next few months.

00:16:13: But, and this is an important caveat, we have to remember liquidity is always potentially existential.

00:16:18: Even for a seemingly solid, batter-rated company, if there was a sudden, sharp, and really unexpected deterioration in their liquidity, maybe a major bank pulls its credit line unexpectedly, or a huge lawsuit suddenly freezes their assets.

00:16:34: that would immediately weigh very negatively on their credit quality, because that immediate risk of not being able to pay bills can suddenly override almost every other structural strength they might possess.

00:16:43: Yeah, the threat of immediate collapse trumps everything else until that threat is resolved.

00:16:48: It's like the ultimate triage for credit quality assessment.

00:16:50: Well put.

00:16:51: So wrapping this up, what does this all mean for you, our listener?

00:16:55: While our deep dive today really confirms a crucial maxim.

00:16:58: especially if you're involved in high yield investing or credit analysis.

00:17:02: When you're looking at companies teetering near the edge of distress, survival is often defined less by how high their total debt burden is and much more by the certainty of their short-term cash runway.

00:17:13: You know, they're operating cash flow plus guaranteed access to external funding like those RCFs.

00:17:19: If you really want to figure out who's likely to survive a downturn, you need to find the companies with the most oxygen, the most certain liquidity.

00:17:25: Yeah, and that brings us back to that really critical data point we uncovered earlier.

00:17:29: If liquidity is truly the key determinant of immediate survival at the low end, and if, as of July, a huge, thirty-seven percent of all caravan issuers globally had weak liquidity assessments, well, that represents a very large segment of the market facing severe immediate pressure.

00:17:46: What that high proportion might be telling us is that there's a large pool of low-rated companies currently operating without much of a safety net, which means if operational continue, or if high interest rates keep biting, we should probably anticipate seeing future default rates rising significantly, specifically among that exposed carrier one group.

00:18:04: It really highlights where the next potential wave of defaults is likely to originate from.