2016 was a rough year for the so-called brick-and-mortar retailers with several mall-based apparel companies, including Aéropostale, Pacific Sun and American Apparel, being forced to seek chapter 11 bankruptcy protection. Meanwhile, The Sports Authority didn't even bother with a reorg plan as creditors decided that a liquidation was the best way to maximize value for creditors.

But it's not just the niche apparel retailers that are having a hard time competing for those scarce consumer dollars. Target plunged as much as 14% on the open this morning after announcing that steep price cuts would be required in 2017 to compete with the likes of Wal-Mart and the online retailing giant, Amazon (see "Target Plunges 12% After Missing Lowest EPS Estimate, Slashing Outlook").

Unfortunately, at least according to Moody's retail credit analyst Charlie O'Shea, the environment for retailers in the U.S. is likely to get worse before getting better. As Moody's notes, the number of distressed U.S. retailers has more than tripled since the Great Recession of 2008-2009, and with $5 billion worth of debt maturities over the next 4 years, the situation is likely to get much worse.

Over the past six years the number of US retailers on the lowest and distressed tier of its rating spectrum has tripled, Moody's Investors Service says in a new report. Not since the 2008-09 recession has the percentage been so high, and the rising tide coincides with an increasing number of such companies across all industries. "Moody's-rated US retailers rated Caa or Ca today make up just over 13% of our total rated retail portfolio, which is the highest level since the Great Recession, when this group comprised 16% of the portfolio," said Moody's Vice President Charlie O'Shea. "And the increase comes at the same time as the broader universe of Caa rated companies is likewise growing."

Meanwhile, the latest round of retailing failures is just another example of the unintended consequences of the Fed's "lower for longer" interest rate policy as private equity sponsors took advantage of cheap debt capital to snap up retailers with minimal equity exposure. As Moody's accurately notes, once the retail meltdown starts, companies can either choose to give up volume to preserve margin or slash prices resulting in a 'race to the bottom'...

This situation comes on the heels of a protracted period of low interest rates, when the availability of cheap money serves as a "dinner bell" for sponsors to feast on target companies, O'Shea says in "Distressed Retailers Are on the Rise; Who's Next?" Each such cycle begets a new pool of B2 or B3 rated companies, which don't have far to fall into the lowest rating tier. Among companies, Claire's, J Crew, Tops and rue21 have all been hamstrung with weak credit metrics after taking on high levels of debt to fund acquisitions. And while the number of low-rated retailers is growing, so are debt maturities, Moody's says. The 19 Caa/Ca companies in the agency's retail portfolio owe roughly $5 billion in debt through 2021, with about 40% of this due by the end of 2018 and a spike during 2019. While the credit markets remain open to companies up and down the rating spectrum, that could change abruptly if investor sentiment turns. Among other considerations, interest rates have begun to trend upward, while US speculative-grade companies have a record $1 trillion of debt coming due in the next five years, which could make refinancing much more difficult for distressed names. Meanwhile, a larger pool of low-rated retailers also poses challenges for their stronger competitors. "As they struggle to survive, distressed retailers can take more desperate measures, including highly promotional pricing that can border on irrational," O'Shea added. "This leaves stronger firms with the choice of either competing in a race to the bottom, or giving up sales in order to preserve margin."

...clearly Target has chosen the "race to the bottom" approach...