Italy's Coming Credit Crunch

As a wave of corporate paper comes due, cash-strapped companies are in peril

Italtractor is the kind of company that has helped transform central and northern Italy into one of the most dynamic manufacturing zones in Europe. In early 2002 business was good, and Italtractor was eager to expand. Taking advantage of rock-bottom interest rates on euro-denominated corporate debt, the $300 million Modena-based maker of components for heavy equipment manufacturers such as Deere & Co. (DE ) issued $126 million in bonds. Although the notes were unrated, they bore an attractive 6.5% yield, and some 3,500 local investors snapped them up. Then Italtractor ran into a headwind -- in part because of the soaring euro. Now it can't pay off the two-year bonds as scheduled in early February; investors will probably have to accept a four-year moratorium on repayment.

That's the harsh new reality of Italian business in the wake of the collapse in December of Parmalat, the Parma-based food and milk-products company. With a wave of unrated bonds coming due, scores of Italian companies may face a payment squeeze similar to Italtractor's.

This year and 2005 are expected to be the peak years of redemption because much of the unrated Italian paper was issued around the time Italy embraced the euro in 1999 and has a maturity of four years. And there's a lot of paper out there: Italian portfolios are stuffed with $17.6 billion in outstanding unrated corporate bonds, according to estimates from Standard & Poor's, which calculates that over $4 billion is coming due in the next two years. Worse, since Italy's market for unrated bonds collapsed in late 2002, companies may find it hard to refinance the obligations. Meanwhile, banks are under pressure to curtail new corporate loans, cutting off another crucial source of financing. "Parmalat came at a particularly nasty time because of the great borrowing needs in Italy," says Ruggero Magnoni, vice-chairman of Lehman Brothers (LEH ) Europe.

Unlike Parmalat, most Italian companies facing a bond crunch haven't been implicated in fraud. Instead, they are suffering low cash flow due to more prosaic problems, such as stagnant sales. Nonetheless, a number of well-known companies swear they will keep current on their payments. "The bond will be paid on schedule," says Jason Weisenfeld, worldwide communications director for fashion house Versace, which has a major chunk of debt coming due.

But the Parmalat scandal has severely dented confidence in Italian capital markets. No surprise, then, that yields on corporate debt are rising and that demand for new issues has evaporated. "There's a huge credit crunch coming for Italian corporations," says Keith Mullin, London-based director of global capital markets for Toronto's Thomson Financial (TOC ).

THE BRIGHT SIDE? The roots of the problem date back to the late 1990s, when Italy was preparing to abandon its volatile lira for the much more solid euro. Many Italian companies turned from bank financing to raising cash through eurobonds with relatively low interest rates. At the same time, Italian investors were looking to diversify their portfolios because short-term government bonds were hit by plunging interest rates and lower public financing needs. While most corporates were investment grade, billions in unrated bonds were sold to small investors. The debt was often issued by familiar companies like Cirio, a food group that defaulted on $1.3 billion in unrated bonds in late 2002.

There could be a silver lining. Bondholders and banks are demanding substantial restructuring in return for fresh financing. Italtractor, for one, has been forced to hire a new CEO and cut its 1,700 member workforce by 12%. "Ultimately, a new, stronger company will emerge," says Isidoro Lucciola of Milan consultant Value Partners, which has been assisting Italtractor. Today's troubles could mean a stronger Italy Inc. tomorrow -- but the fix will come at a high price.

By John Rossant in Paris

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