Case 12: Fruit of the Loom

The Standard & Poor's CreditWire recently reported that Fruit of the Loom's 8.875% senior notes, which mature in 2006, were downgraded from BB- to B. This downgrade came after the company recently amended its credit agreement on all other outstanding issues which effectively made the 8.875% notes subordinate to existing claims.

Since this represented a mere shuffling of priority claims, Fruit of the Loom's overall corporate credit rating remained at BB- as did the rating of all but one other claim (an $850 million senior unsecured debt shelf filing was downgraded to B as well). The corporate BB- rating was justified by Standard & Poor's because while Fruit of the Loom still has strong brand name recognition and holds significant market share in underwear, imprinted T-shirt and fleece markets, they are having performance and operational difficulties.

Below is a qualitative description of each of Standard & Poor's bond rating categories.

AAA–An obligor rated 'AAA' has EXTREMELY STRONG capacity to meet its financial commitments.

AA–An obligor rated 'AA' has VERY STRONG capacity to meet its financial commitments. It differs from the highest rated obligors only in small degree.

A–An obligor rated 'A' has STRONG capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

BBB–An obligor rated 'BBB' has ADEQUATE capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitments.

BB–An obligor rated 'BB' is LESS VULNERABLE in the near term than other lower rated obligors. However, it faces major ongoing uncertainties and exposure to adverse business, financial, or economic conditions which could lead to the obligor's inadequate capacity to meet its financial commitments.

B–An obligor rated 'B' is MORE VULNERABLE than the obligors rated 'BB', but the obligor currently has the capacity to meet its financial commitments. Adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitments.

CCC–An obligor rated 'CCC' is CURRENTLY VULNERABLE, and is dependent upon favorable business, financial, and economic conditions to meet its financial commitments.

CC–An obligor rated 'CC' is CURRENTLY HIGHLY VULNERABLE.

R–An obligor rated 'R' is under regulatory supervision owing to its financial condition. During the pendency of the regulatory supervision the regulators may have the power to favor one class of obligations over others or pay some obligations and not others. Please see Standard & Poor's issue credit ratings for a more detailed description of the effects of regulatory supervision on specific issues or classes of obligations.

SD and D–An obligor rated 'SD' (Selective Default) or 'D' has failed to pay one or more of its financial obligations (rated or unrated) when it came due. A 'D' rating is assigned when Standard & Poor's believes that the default will be a general default and that the obligor will fail to pay all or substantially all of its obligations as they come due. An 'SD' rating is assigned when Standard & Poor's believes that the obligor has selectively defaulted on a specific issue or class of obligations but it will continue to meet its payment obligations on other issues or classes of obligations in a timely manner. Please see Standard & Poor's issue credit ratings for a more detailed description of the effects of a default on specific issues or classes of obligations.

Note: Obligors rated 'BB', 'B', 'CCC', and 'CC' are regarded as having significant speculative characteristics. 'BB' indicates the least degree of speculation and 'CC' the highest. While such obligors will likely have some quality and protective characteristics, these may be outweighed by large uncertainties or major exposures to adverse conditions.

Plus (+) or minus (-): Ratings from 'AA' to 'CCC' may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories.

Source: Standard & Poors

Questions

1. Define what is meant by "a Pecking Order."

2. Why is it, specifically, that the 8.875% bond received a downgrading from BB- to B?

3. Should the stock price react to this bond's down rating? Why or why not?

4. Why is it that firms in different industries can have the same capital structure and the same Earnings Per Share (EPS), but still have a different bond rating?