default rate to reach six-year high in 2016default rate to reach six-year high in 2016 » we project...

CORPORATES

SECTOR IN-DEPTH29 January 2016

TABLE OF CONTENTSDefault rate to reach six-year high in2016 2Oil slump propels defaults to highesttally since 2009 2Liquidity and credit red flagsdeteriorate sharply in fourth quarter 4Stress modest but edging higheroutside of commodity sectors 6Downgrades push Caa2-PD-and-lower pool to six-year high 9Downgrades to Caa2 or below 9Upgrades to Caa1 and above 13Appendix A 15Moody's Related Research 16

Contacts

John E. Puchalla, CFA 212-553-4026Senior Vice [email protected]

Tom Marshella 212-553-4668Managing Director– US and AmericasCorporate [email protected]

US Corporate Default Monitor - Fourth Quarter 2015

Default Rate to Reach Six-Year High in 2016» We project that the US speculative-grade default rate will climb to 4.4% in

2016, marking the highest level since mid-2010. Ongoing cash flow deteriorationin oil & gas (O&G) was the biggest factor behind the default rate’s rise to 3.2% from2.7% in the fourth quarter. Along with other commodity sectors, we expect O&G willcontinue to exert the biggest upward default rate pressure in 2016. The share of US spec-grade issuers rated B3 and lower is already above the peak level in the last recession. Thesizable pool of low-rated credits indicates that the odds of the default rate eclipsing its4.8% average since 1990 will grow if the economy sours and spread widening continues.

» Oil slump propels 2015 defaults to highest tally since 2009. Nine of the 15 US non-financial corporate defaults in the fourth quarter were O&G companies, with the sectoraccounting for 25 of the 56 defaults in 2015. That was the most US spec-grade defaultssince the 2009 recession year, when the count was 167, and more than double the 25defaults in 2014. Metals and mining contributed the second highest sector default countat seven, further demonstrating that the sharp drop in prices is exerting pressure on cashflow and liquidity of commodity-based companies.

» Liquidity and credit red flags deteriorate sharply in fourth quarter. Our defaultrisk indicators deteriorated in the fourth quarter, driven by energy. Our Liquidity StressIndex (LSI) moved above its long-term average to finish the year at 6.8%, the highestsince February 2010, while the count of issuers rated Caa2-PD-or-lower surged 54% to74. Downward earnings and cash flow pressure resulting from lower energy prices is thebiggest culprit. Our oil & gas LSI surged to 19.6% from 4.5% during 2015 and is withinrange of its 24.5% record high from March 2009. As discussed in our January 21 SGLMonitor publication, a “10-40” break, where the LSI moves above 10% with more than40% of sectors above that level, would signal a more worrisome climb in the defaultrate. In December, only two of the 21 industries we track had a sector LSI above 10% -both in oil & gas. Reflecting the recent pullback in spec-grade debt issuance, our three-year Refunding Index maturity coverage ratio fell to a six-year low of 4.9x in December.

» Stress modest but edging higher outside of commodity sectors. Defaults in non-commodity sectors were up only slightly to 24 in 2015 from 21 in 2014, but default riskis edging higher for this group based on their LSIs and rating transitions. Liquidity andcredit rating trends indicate a rising but contained default rate. Low but still positiveeconomic growth, modest 2016 maturities, and a lack of widespread covenant violationrisk continue to support liquidity and dampen the number of defaults. Low-rated issuersare nevertheless confronting headwinds from higher borrowing costs, which is making itmore difficult to avoid default by resolving a liquidity problem in the credit markets.

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MOODY'S INVESTORS SERVICE CORPORATES

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.

2 29 January 2016 US Corporate Default Monitor - Fourth Quarter 2015: Default Rate to Reach Six-Year High in 2016

Default rate to reach six-year high in 2016Pressure on cash flow following from the sharp pullback in commodity prices is pushing the default rate higher. After rising to 3.2%from 2.7% in the fourth quarter, we project the US speculative-grade default rate will climb to 4.4% in 2016, marking the highestlevel since mid-2010. Defaults were heavily concentrated in oil & gas (O&G) and other commodity-related sectors in 2015 and weexpect this pattern to continue in 2016 at a higher overall level of defaults. However, the magnitude of the default rate’s climb will alsodepend on whether credit strains extend more broadly to non-commodity sectors.

Our red flag indicators – our LSI and count of low ratings currently suggest default risks outside of commodities are modest for thenext year, with support from positive economic growth, limited near-term maturities and a lack of widespread covenant issues. Evenso, we are starting to see liquidity and negative rating transitions seep into these non-commodity sectors. This increases the potentialfor a more pronounced rise in the default rate if economic growth slows or credit losses in energy and tighter monetary policy causeinvestor risk aversion to grow. This would hurt corporate cash flow and make it more difficult for low-rated borrowers to resolveliquidity issues.

Default potential also exists because the backdrop is that the profile of spec-grade issuers from a ratings perspective is weak. The shareof US spec-grade issuers with a Corporate Family rating of B3 or lower is already above levels reached in the last recession. This shareclimbed to roughly 35.3% from 32.4% in 2015, eclipsing the prior annual peak of 32.5% reached at the end of 2009 (see Exhibit 1).Because low-rated issuers are less able to weather through a period of weak earnings and liquidity pressure, they are more vulnerable todefault. The odds of the default rate eclipsing its 4.8% average since 1990 will therefore grow if the economy sours and credit spreadwidening continues.

Exhibit 1

Weakening Rating Distribution Warns of Higher Default Rate in 2016

Default rate for 2016 is Moody's projection; ratings are Corporate Family Rating.Source: Moody's Investors Service

Oil slump propels defaults to highest tally since 2009The fourth quarter default count and amount of defaulted debt was similar to the third quarter, but continues to run well ahead of2014 (see Exhibit 2, page 3). Nine of the 15 US non-financial corporate family defaults in the fourth quarter were O&G companies(see Exhibit 4, page 4 for a list of fourth quarter defaulting issuers), with the sector accounting for 25 of the 56 defaults in 2015. Thatwas the most US spec-grade defaults since the 2009 recession year, when the count was 167, and more than double the 25 defaults in2014.

The default count was unchanged from 15 in the third quarter while the amount of defaulted debt dipped slightly to $18.2 billion from$18.7 billion. Defaulted debt rose 38% to $71.6 billion in 2015 despite the presence of Energy Future’s $39.2 billion of then-rated debtin 2014’s tally. Defaults in 2015 affected a much broader pool of larger issuers. The number of companies that defaulted on more



than $1 billion of debt jumped to 17 in 2015 from just three in 2014. Caesar’s Entertainment’s bankruptcy filing in January was thelargest default in 2015 ($20.5 billion of rated debt), but ten of the 17 companies with more than $1 billion of defaulted debt were in theenergy sector.

Exhibit 2

US Corporate Family Defaults Rose in 2015, Hitting Highest Level in Five Years

Source: Moody's Investors Service

The jump in commodity sector defaults was responsible for the increase in the US spec-grade default rate in 2015 (see Exhibit 3).Excluding oil & gas and metals & mining, the default rate dipped to 1.6% from 1.7% last year. In contrast, the default rate for oil & gasand metals & mining soared to 13.2%.

Exhibit 3

US Spec-Grade Default Rate Dipped in 2015 Excluding the Jump in Commodity Sector Defaults


Energy companies have cut back new investments, reduced staff, and curtailed costs to counteract the roughly 70% drop in oil pricesfrom their peak in June 2014. Significant earnings declines are nevertheless reducing cash flow. A rally in prices in the spring of 2015helped companies access credit markets to shore up liquidity. But renewed oil price declines led to sizable losses for investors, leadingto much higher borrowing costs that are curtailing issuers' market access. Metals and mining contributed the second highest sectordefault count at seven in 2015, further demonstrating that the sharp drop in prices is exerting pressure on cash flow and liquidity ofcommodity-based companies.



Exhibit 4

US Corporate Family Defaults - Fourth Quarter 2015Company Default Type IndustryAffinion Group Holdings, Inc. Distressed exchange Services: BusinessAmerican Apparel, Inc. Bankruptcy Retail: SpecialtyCalifornia Resources Corp. Distressed exchange Energy: Oil & Gas Exploration & ProductionChesapeake Energy Corporation Distressed exchange Energy: Oil & Gas Exploration & ProductionDex Media, Inc. Missed interest payment Media Publishing: BooksEXCO Resources, Inc. Distressed exchange Energy: Oil & Gas Exploration & ProductionGetty Images, Inc. Distressed exchange Media: Media ServicesLinn Energy, LLC Distressed exchange Energy: Oil & Gas Exploration & ProductionLogan's Roadhouse Inc. Distressed exchange Restaurants: Family DiningMagnum Hunter Resources Corporation Bankruptcy Energy: Oil & Gas Exploration & ProductionMillennium Health, LLC Bankruptcy Services: ConsumerOffshore Group Investment Limited Bankruptcy Energy: Oil Services - DrillingSheridan Investment Partners II, LP Distressed exchange Energy: Oil & Gas Exploration & ProductionSwift Energy Company Missed interest payment Energy: Oil & Gas Exploration & ProductionWarren Resources, Inc. Distressed exchange Energy: Oil & Gas Exploration & Production


Commodity-related sectors continue to present the most default risk in 2016. Factoring in both investment-grade and speculative-grade borrowers, the sectors with the highest default rate forecasts in 2016 are metals & mining and oil & gas (see Exhibit 5). However,oil & gas companies account for 58% of the companies with our weakest liquidity rating at the end of 2015, which warns that thesector will contribute the most defaults among speculative-grade companies.

Exhibit 5

Commodities Top US Corporate Sectors with the Highest Default Rate Forecast for 2016Industry 1-Year Default ForecastMetals & Mining 10.4%Energy: Oil & Gas 5.7%Services: Business 4.0%Aerospace & Defense 4.0%


Liquidity and credit red flags deteriorate sharply in fourth quarterDefault red flags deteriorated in the fourth quarter and support our forecast for a higher default rate in 2016. The LSI moved aboveits long-term average to finish the year at 6.8%, the highest since February 2010 (see Exhibit 6, page 5), while the count of issuersrated Caa2-PD-or-lower surged 54% to 74. Downward earnings and cash flow pressure resulting from lower energy prices remainsthe biggest driver of defaults. Our oil & gas LSI surged to 19.6% from 4.5% during 2015 and is within range of its 24.5% record highfrom March 2009 (see Exhibit 7, page 5). Reflecting the overhang from the recent drop in spec-grade debt issuance, our three-yearRefunding Index maturity coverage ratio fell to a six-year low of 4.9x in December.



Exhibit 6

LSI's Climb Warns of Higher Default Rate in 2016

January - December 2016 is projectedSource: Moody's Investors Service

We anticipate that energy sector liquidity pressures will increase because of persistently weak cash flow, impending borrowing baseredeterminations, and the roll-off of favorable price hedges. We revised lower our oil & gas price expectations several times overthe last three months on oversupply and weakening demand. This includes a reduction in our 2016 oil price forecast for West TexasIntermediate to $33 per barrel that coincided with Moody’s placing the long-term ratings of 120 oil & gas companies on review fordowngrade on January 22.

Exhibit 7

Liquidity Pressures Remain Mild Outside of Oil & Gas


Moody’s Liquidity Stress Index has been a consistent indicator of default pressures (Exhibit 6), and is measured as the percentage ofcompanies with the weakest of our four speculative-grade liquidity ratings. The LSI jumped to 6.8% from 5.8% in the fourth quarterand has trended higher since its recent bottom at 3.5% in November 2014. Pressure on cash flow – in oil & gas and other commoditysectors in particular – is the biggest factor pushing the LSI higher. Apart from this, liquidity pressures are reasonably contained thanksto a manageable slate of 2016 maturities and low risk of covenant violations.

The prevalence of covenant lite structures continues to be a positive factor limiting default risk. Moody’s Covenant Stress Index (MCSI)actually fell to 2.7% from 3.1% in the fourth quarter and remains comfortably below its 5.8% long-term average since 2002 (seeExhibit 6). The MCSI reflects the percentage of SGL-rated companies with the weakest score for the covenant component of ourliquidity analysis, and the index increases when the risk of covenant violations grows.



A surge in the population of low-rated issuers points to an increase in defaults in 2016. Downgrades pushed the count of issuers witha Probability of Default (PD) rating of Caa2-PD or lower up by 54% to 74 in the fourth quarter. The count of these companies, whichhave elevated default risk over the next two years, jumped to 5.2% of US speculative-grade corporate families at the end of 2015, thehighest since 2009. The share of US issuers with a PD rating of Caa2-PD or lower crested at 8.8% at the end of 2008, roughly a yearbefore the US spec-grade default rated peaked at 14.7% in November 2009.

Exhibit 8

Maturity Coverage Declines as Bond Issuance Slows

Moody's Refunding Index is a ratio of debt issuance to upcoming maturities. It increases when refunding risk falls. For more information about the index, please see Moody's RefundingIndex, Frequently Asked Questions.Source: Moody's Investors Service

The slowdown in spec-grade debt issuance and spread widening means companies will have a tougher time addressing upcomingmaturities. Moody’s Refunding Index (RI) indicates that coverage of bond maturities at the current pace of bond issuance continues todecline, with the one-year RI dropping to 11.4x from 14.8x in the fourth quarter. Bond maturities in 2016 are nevertheless modest andthe RI remains well above its record low of 2.4x in January 2009 (see Exhibit 8).

Stress modest but edging higher outside of commodity sectorsDefaults and our red flag indicators of future default risk remain concentrated in oil & gas companies, but there are signs of modeststrain for low-rated issuers in other sectors. Defaults outside of commodity sectors were up only slightly to 24 in 2015 from 21 in 2014,but default risk is edging higher based on our LSI and low-rated issuer count.

A wide gulf between default risk in oil & gas and other sectors is evident in our red flag indicators. The oil & gas LSI surged to 19.6%from 4.5% during 2015 and is within range of its 24.5% record high from March 2009 (see Exhibit 7, page 5). In contrast, the LSIexcluding oil & gas was at 3.6% at the end of 2015 and remains closer to the record low of 2.6% reached in February 2015 than its6.5% long-term average.

As discussed in our January 21 SGL Monitor publication, a “10-40” break (an LSI above 10% with more than 40% of sectors above thatlevel) would signal a more worrisome climb in default risk. In December, only two of the 21 industries we track had a sector LSI above10% - both in oil & gas (see Exhibit 9, page 7). Other commodity-oriented sectors with LSIs close to 10% were metals & mining andpaper, packaging & forest products. Leading into the last major default cycle, the “10-40” conditions were first met in May 2008 whenthe default rate was only 2.4% but was starting to move sharply higher.

The red flag trends outside of oil & gas are negative, but not as pronounced. A majority of sector LSIs (14 of 21) increased in 2015 (seeExhibit 9, page 7) with the three largest gains in energy-related industries. But the increase in the default rate will be mild if energyweakness does not spread broadly to other sectors.



Exhibit 9

Liquidity Stress Highest Among Energy Companies

Count is companies with a SGL-4 rating; ranking based on highest to lowest sector LSIsEnergy E&P is independent exploration & production; Energy OFS is oilfield servicesEnergy Other is midstream and refining & marketing; Metals & Mining includes coalIn the “Yearly Change” column, darkening red indicates increases, while darkening green indicates decreasesSource: Moody's Investors Service

Other red flags show a similar sector disparity, with oil & gas representing 43% of the non-financial companies with a PD rating ofCaa2-PD or lower at the end of last year (see Exhibit 10, page 8).



Exhibit 10

Energy Accounts for Over 40% of Caa2-PD-and-lower Rated IssuersMean One-Year Default Rate For These Rating Categories Exceeds 15% from 1983-2014

Population is companies with a probability of default rating of Caa2-PD or lowerEnergy E&P is independent exploration & production; Energy OFS is oilfield servicesEnergy Other is midstream and refining & marketing; Metals & Mining includes coalIn the “Quarterly Change” column, darkening red indicates increases, while darkening green indicates decreasesSource: Moody's Investors Service

The increase in the Caa2-PD and lower population was led by energy but also included a sizable increase in companies from othersectors – to 42 from 30 in the fourth quarter. Some of the downgrades – for example chemical company American Gilsonite andequipment rental service provider Sprint Industrial Holdings – were a by-product of reduced drilling activity and equipment utilizationin the oil & gas sector. Other downgrades were attributed to revenue weakness that is pressuring cash flow, contract losses, andapproaching debt maturities. Summary rationales for the 30 companies downgraded to Caa2-PD and lower in the fourth quarter are inthe section that follows. Maturities in 2016 and 2017 are not widespread for companies with a PD rating of Caa2-PD or lower with 11 ofthe 74 having a 2016 maturity and 15 having a 2017 maturity (see Exhibit 12, pages 13 and 14).

Low-rated issuers are also confronting headwinds from higher borrowing costs and a tepid global growth outlook. Liquidity pressure isless likely to lead to defaults when favorable credit and financial market conditions allow companies to cost-effectively resolve liquidityissues. Default risk grows when credit conditions are tighter because the cost of resolving a liquidity issue by raising new debt oramending covenants can become cost-prohibitive for some companies. The significant widening of credit spreads especially at lower-rating levels, is driving up spec-grade borrowing costs. This is worrisome when coupled with the LSI’s rise. Because spread widening isat least partially attributable to mounting credit losses on commodity investments, the downdraft in commodity prices is increasingdefault risk among low-rated companies in other sectors even when such sectors are growing.

Economic growth must be strong enough to create a bulwark that prevents credit losses from spreading broadly beyond commoditysectors. Moody’s Macroeconomic Board’s projection for 2.0% - 3.0% US real GDP growth in 2016 should be sufficient to limit the rise



in the default rate this year. But the Board views growth and global financial stability as being particularly vulnerable to shocks for anextended period of time, and any weakening of the growth outlook is likely to further elevate default risk.

Downgrades push Caa2-PD-and-lower pool to six-year highThe population of companies with PD ratings of Caa2-PD or lower jumped to 74 from 48 in the third quarter with 30 companiesjoining the list via downgrades (see Exhibit 11,). That doubled the 15 downgrades to the list in the third quarter, continuing anacceleration trend that suggests the pipeline of companies at elevated risk of default is growing. An increasing number of companiesthat recently defaulted through distressed exchanges remain on the list. That's because their capital structures remain strained (seeExhibit 12, pages 13 and 14 for the list of companies with a PDR of Caa2-PD or lower at the end of 2015).

Half of the 30 PDR downgrades to Caa2-PD or lower were in energy including 12 exploration & production companies. The only othersectors with multiple downgrades were metals & mining (4) and automotive parts (2). Affinion was the only company to be upgradedoff the Caa2-PD and lower list during the fourth quarter, with the action following a distressed exchange that reduced debt. A briefdiscussion of the companies moving on and off of the Caa2-PD or lower list in the fourth quarter follows Exhibit 11.

Exhibit 11

Caa2-PD-and-lower List Jumps 54% in Fourth Quarter, Doubles in 2015Companies with a PD rating of Caa2-PD or lower


Downgrades to Caa2 or belowAmerican Energy - Permian Basin, LLC (Caa3 Negative, Caa3-PD): Downgraded to Caa3 from Caa1. AEPB's issuance of first liennotes improves its liquidity marginally, but worsens the already elevated debt burden and leverage metrics. Absent an unexpectedcommodity price recovery, AEPB's incremental interest burden and planned capital expenditures through 2016 will leave AEPB withlittle liquidity at the end of 2016 and with potentially few meaningful options to shore up its liquidity. AEPB's Caa3 CFR reflects thecompany's very high leverage relative to its cash flow and asset value, coupled with high on-going liquidity needs.

American Gilsonite Holding Company (Caa2 Negative, Caa2-PD): The downgrade to Caa2 from B3 results from significantearnings deterioration due to volume declines in its largest end-use application - drilling fluids. Additionally, we believe that anextended period of low oil prices will limit the company's ability to repay or refinance its notes due in September 2017. Persistently lowoil prices will deter rig count improvements and continue to pressure American Gilsonite's volumes and earnings.

Aspect Software, Inc. (Caa2 Negative, Caa2-PD): The downgrade to Caa2 from B3 was driven by challenges the company isfacing in offsetting declines in its legacy product lines, high debt levels and upcoming debt maturities. The company has grown its nextgeneration unified IP contact center lines and its broad cloud offerings, and overall revenues and EBITDA are expected to return togrowth over time. Given the uncertainty over that timing however, the high debt levels and imminent maturities, the ratings have beendowngraded. The ratings reflect the risk that a default under Moody's definition, potentially through a distressed exchange, is possibleover the next year given imminent debt maturities and very high leverage.



Autoparts Holdings Limited (Caa2 Negative, Caa2-PD): The downgrade to Caa2 from Caa1 reflects 2015 operating results thathave failed to meet our expectations and lag the already weak results of 2014. The downgrade incorporates the company's weakoperating performance, the looming maturity of the $50 million revolving credit facility, and the ongoing strategic review announcedin September of last year. Credit metrics have further deteriorated with LTM EBITA/Interest dropping to 1.2x as of 9/30/15 from 1.6xin the prior year period and debt/EBITA increasing to 7.7x (6.0x excluding factored accounts receivables) from 6.3x. The company'sperformance was negatively impacted by a drop in revenue (by 6.6%), and higher manufacturing and materials costs.

Comstock Resources, Inc. (Caa2 Negative, Caa2-PD): The downgrade to Caa2 from Caa1 stems from Comstock's disclosurethat it has repurchased $101 million of existing senior unsecured notes for $37.8 million in cash at an average price of 37% of par.We considers Comstock's repurchase of unsecured debt at a deep discount to par as a distressed exchange for its senior unsecureddebt, which we view as a default. The downgrade of Comstock's CFR reflects the company's weak cash flow metrics and potentiallyunsustainable capital structure. A prolonged period of weak commodity prices has compounded the effect of the company's highinterest burden and steep production decline rate, heightening the risk of further debt restructuring.

Dex Media, Inc. (Ca Negative; Ca-PD): We downgraded the CFR to Caa3 from Caa1 on October 19th following Dex Media's decisionto not make its September 30, 2015 scheduled interest payment on its senior subordinated notes as the company's senior lenderscome together to discuss a restructuring. Dex Media has until October 30 to make the missed interest payment before it triggers anevent of default under the indenture. We further downgraded the company to Ca from Caa3 on December 16th because of the missedinterest payment and the subsequent failure to make the payment during the grace period. We viewed this as a limited default as itrepresents a default of only one element of the company's capital structure.

EXCO Resources, Inc. (Caa2 Negative; Caa2-PD): The downgrade to Caa2 from Caa1 was in response to XCO's announcementof a new second lien financing transaction, and reflect a further weakening in XCO's credit profile. We consider XCO's retirement of$577 million of its existing unsecured notes in exchange for $291 of new second lien debt as a distressed exchange default for its seniorunsecured debt. The CFR reflects XCO's weakened credit profile and liquidity due to lower production from its natural gas-weightedportfolio, sustained low retained cash flow relative to debt, and the significant capital required to restore production growth. Whilethe company has reduced costs, low realized natural gas prices and an over-leveraged balance sheet weigh heavily on XCO's ability torepair its credit profile.

Horsehead Holding Corp. (Caa2 Negative; Caa2-PD): The downgrade to Caa2 from B3 results from the continued delays at thecompany's new zinc production facility and reflects the company's weak earnings performance as evidenced by negative EBITDA of $25million for the nine months through September 30, 2015 (including Moody's standard adjustments). The downgrade also considersthe subsequent deterioration of the company's liquidity position as a result of the weak operating performance and continued capitalspending on the new facility. Given the further drop in zinc prices following the third quarter, and the expectation for a protractedindustry recovery period, we expect Horsehead's performance and liquidity to remain pressured over the next twelve months.

Isola USA Corp. (Caa2 Negative; Caa2-PD): The downgrade to Caa2 from B3 reflects our expectations of continuing softness in thecompany's operating performance over the next year as well the growing risk that Isola's overall debt structure may be unsustainable.The CFR reflects the heightened probability of a debt restructuring absent an equity infusion given Isola's weakening credit metrics.

Key Energy Services, Inc. (Caa2 Negative; Caa2-PD): The downgrade to Caa2 from B3 reflects Key's elevated risk of a potentialdefault through 2017. Key entered this downturn with a much higher debt burden, and the severity and protracted nature of thisdownturn along with the impending fines and/or penalties related to the Foreign Corrupt Practices Act (FCPA) violation, will challengeKey's liquidity and its ability to maintain debt service through 2017. We expect low oil and natural gas prices to keep upstreamcustomer demand for oilfield services at depressed levels limiting Key Energy's cash flow generation and deleveraging in the nearfuture.

Kratos Defense & Security Solutions, Inc. (Caa2 Stable; Caa2-PD): The CFR was downgraded to Caa2 from Caa1 because Kratos'revenue decline since 2013 along with an operating cash flow deficit and weak interest coverage of late make the capital structureseem potentially untenable. Over the first nine months of 2015 reported funds from operation interest coverage, pro forma for theAugust 2015 Herley divestiture and associated $216 million debt reduction, was weak at 0.8x. Kratos' estimates that its 2015 debtto EBITDA (excludes a range of special items) ratio will be 10x to 11x. Credit metrics may not materially improve in 2016. R&D and



proposal spending within Kratos' unmanned aerial systems, which has added expense and capital expenditure, will, at a minimum,continue across the first half of 2016.

Linn Energy, LLC (Caa1 Negative; Caa2-PD): The downgrades of the CFR to Caa1 from B2 and PDR to Caa3-PD from B2-PD onNovember 16 were in response to Linn's announcement of a new second lien financing transaction. We considered the retirement of$2 billion of existing unsecured notes in exchange for $1 billion of new second lien debt as a distressed exchange default for LINE’ssenior unsecured debt. The downgrade reflects elevated distressed exchange risk going forward at the company. While LINE's secondlien financing helps to improve the company's leverage metrics, further debt reduction is necessary in order to improve asset coverageof debt as the company's hedge book continues to roll off into materially lower commodity prices. We upgraded to PDR to Caa2-PDfrom Caa3-PD on November 24th following the closing of the debt exchange, but the PDR continues to be one-notch lower than theCFR because of elevated distressed exchange risk going forward.

Peabody Energy Corporation (Caa3 Negative; Caa3-PD): The downgrade to Caa3 from Caa1 reflects our expectation of continueddeterioration in the company's credit metrics due to the ongoing decline in the seaborne metallurgical coal markets and weakness inthe US and seaborne thermal coal markets, as well as our expectation that market recovery will be slower and more protracted thanpreviously anticipated. As of September 30, 2015, the company's Debt/ EBITDA, as adjusted stood at 8.7x, and over the precedingtwelve months the company burned over $500 million in cash. We expect the leverage to continue increasing and liquidity to continuedeteriorating, absent market improvements or deleveraging actions.

Penn Virginia Corporation's (Caa3 Negative; Caa3-PD): The downgrade to Caa3 from Caa1 reflects PVA's high leverage,declining production, declining interest coverage and weak liquidity. The company needs to secure additional financing to continue itsoperations. The company projects its production in 2015 Q4 will decline to 17 Mboepd (from the pro forma peak of 22.8 Mboepd seenin 2015 Q1) and we expect that cuts in capital expenditures necessitated by little operating cash flows and limited external financingwill put further downward pressure on 2016 production volumes.

PTC Group Holdings Corp. (Caa2 Negative; Caa2-PD): The downgrade to Caa2 from B3 reflect PTC's deteriorating credit metrics,weak liquidity profile and the need to address debt maturities due within the next year. PTC's Caa2 corporate family rating reflects itsdeteriorating credit metrics and diminished liquidity profile due to its recent weak operating results and higher than anticipated costson its recently abandoned project to facilitate the production of seamless tubular products.

RGIS Services, LLC (Caa1 Negative; Caa2-PD): The downgrade of the CFR to Caa1 from B3 and PDR to Caa2-PD from Caa1-PDreflects the decreased probability that RGIS will be able to refinance its 2017 maturities without principal impairment or in a mannerthat we do not deem a distressed exchange. In our view, following the acceleration of EBITDA declines in Q3 2015, the likelihoodof near term performance improvement, which is needed to position RGIS for a timely and economical refinancing, has diminished.During the quarter, the negative trends in contract price, wages, customer mix and retailer inventories more than offset productivityimprovements that the company implemented.

Sheridan Investment Partners I, LLC, Sheridan Production Partners I-A, L.P. and Sheridan Production Partners I-M, L.P.'s(collectively Sheridan I; all Caa3 Negative; Caa3-PD): The downgrade of Sheridan I's CFRs to Caa3 from B2 reflect the potentialfor a borrowing base deficiency and the further exacerbation of liquidity stress given low commodity prices. There is a high likelihoodthat Sheridan I will do additional discounted debt prepayments.

Sheridan Investment Partners II, L.P., Sheridan Production Partners II-A, L.P., and Sheridan Production Partners II-M,L.P. (collectively Sheridan II; all Caa3 Negative; Caa3-PD): The downgrade of Sheridan II’s CFRs to Caa3 from B3 reflect thepotential for further exacerbation of liquidity stress due to additional potential borrowing base deficiency driven by the persistent lowcommodity price environment. There is high likelihood that Sheridan II will do additional discounted debt prepayments. On November25, 2015 Sheridan II amended its senior secured term loan to introduce a process for lenders to voluntarily tender their loans forprepayment. As a result of this transaction, Sheridan II prepaid $70 million principal amount of the term loans at 66.875% of the parvalue. We considered the prepayment of term loans at a discount as a distressed exchange default.

Sierra Hamilton, LLC (Caa3 Negative; Caa3-PD): The downgrade to Caa3 from Caa1 reflects our expectation for sustained weakactivity levels that will make covering interest payments very challenging by the latter half of 2016. The company's debt was issued in a



market with a much higher level of rig activity, having fallen more than 50% since its peak over a year ago. The capital structure will beunsustainable absent a sharp recovery.

Sprint Industrial Holdings, LLC (Caa2 Negative; Caa2-PD): The downgrade to Caa2 from Caa1 was due to deterioration in thecompany's operating performance due to end market weakness, as well as further weakening of the liquidity profile. The company'soperating performance is weaker than expected, which is primarily attributable to a decline in demand and equipment utilization rateswithin the oil and gas sector. Reduced demand due to sustained softness in energy markets has contributed to operating losses andadjusted debt/EBITDA over 8.0x for the 12 months ended September 30, 2015 (metrics incorporate Moody's standard adjustments foroperating leases).

Stallion Oilfield Holdings, Inc. (Caa1 Negative; Caa2-PD): The downgrade of the CFR to Caa1 from B3 and PDR to Caa2-PD fromB3-PD reflects Stallion's elevated leverage metrics and weak interest coverage. We expect demand for wellsite services to remain weakthrough 2016, keeping Stallion's cash flow metrics under pressure.

Swift Energy Company (Caa3 Negative; Ca-PD): The downgrade to Caa3 from Caa1 resulting from the continuing deterioration inSwift's liquidity and its weakened fundamental credit profile, which culminated in the company's election to not make an $8.9 millioninterest payment due December 1 on its 2017 notes. Given the accelerated erosion in Swift's liquidity position in 2015's third quarter,we regard a distressed debt restructuring or bankruptcy filing to be a near certainty. The coupon skip is ample evidence of the severestress under which Swift is operating in this very weak commodity price environment.

UCI International, LLC (Caa3 Stable; Caa3-PD): The downgrade to Caa3 from Caa1 reflects the continued softness in UCI'sbusinesses, the resulting negative free cash flow generation, and questionable sustainability of UCI's capital structure. Results for itsongoing business over the recent quarters continued to demonstrate lower customer pricing and volumes, a product mix of lowermargin products, and higher manufacturing and distribution costs. Leverage is expected to remain in the double digit range (pro formaan asset sale) until operational restructuring, and optimization actions have been completed.

Valitas Health Services, Inc. (Caa3 Negative; Caa3-PD): The downgrade to Caa3 from Caa1 reflects our concerns regarding thecompany's weak liquidity profile, including minimal cushion under the company's financial covenants due to earnings volatility andapproaching step-downs. As a result, we expect that a waiver or an amendment will be required over the near-term. The company'sweak liquidity profile also reflects approaching debt maturities, including the company's revolver expiration in June 2016 and termloan maturing in June 2017. The downgrade also reflects uncertainty related to the company's Florida contract, the company's largestcustomer, as the state announced its plan to place its healthcare services contract up for re-bid by the end of 2015.

Verso Paper Holdings LLC (Caa2 Negative; Caa2-PD): The downgrade to Caa2 from B3 reflect our view of the increased likelihoodthat Verso will default on some of its debt following the company's announcement that it has begun evaluating potential restructuringalternatives. The Caa2 CFR reflects the elevated risk of a default as the company explores potential restructuring alternatives, thecompany's weak liquidity, high leverage (projected adjusted leverage of about 7x) and the expectation that the company will continueto face secular demand declines and weak prices for most of the grades of coated paper it produces.

Wise Metals Intermediate Holdings (Caa2 Negative; Caa2-PD): The downgrade to Caa2 from B3 reflects the weak performanceof Wise to date in 2015, the continued deterioration in debt protection metrics and increase in leverage, which, as measured by thedebt/EBITDA ratio is approximately 13x for the 12 months ended September 2015. In addition, the downgrade considers the fact thatbased upon Wise's current performance it is unable to cover its interest payments and has relied on its parent, Constellium (B3 CFR )to provide support. The downgrade factors in the potential that Constellium may not continue to provide support. The downgrade alsoconsiders the announcement that Wise Alloys (the principal operating subsidiary) is exploring ways to refinance its ABL facility, whichwould include seeking to eliminate Constellium's guarantee and the announcement by Constellium that it is exploring alternatives forWise.



Upgrades to Caa1 and aboveAffinion Group Holdings, Inc. (Caa1 Stable; Caa1-PD): The upgrade to Caa1 from Caa2 follow the completion of a recapitalizationon November 9, 2015 that raised $110 million of new capital for Affinion in a rights offering and exchanged approximately $585million of Affinion Investments, LLC's outstanding 13.5% senior subordinated notes due 2018 and Affinion's outstanding 13.75%/14.5%senior secured PIK/Toggle notes due 2018 for equity of Affinion. We deemed the exchange of the notes to be a distressed exchange.We expect the company to benefit from the revised capital structure including meaningful reduction in debt service costs andcorrespondingly stronger cash flow. We also expect the quality of earnings to improve, with fewer one-time cash charges and bettercash flow conversion.

Exhibit 12

Companies with a PD rating of Caa2-PD or Below; Maturities in 2016 and 2017 not widespread

Company

Probabilityof Default

Rating

CorporateFamily Rating

& Outlook SGL Rating Industry Sector 2016 2017A.M. Castle & Co. Caa2-PD Caa2, NEG SGL-3 Wholesale Distribution: Metals $210 BCF Abaco Energy Technologies LLC Ca-PD Caa3, NEG SGL-4 Energy: Oil Services AM General, LLC Caa2-PD Caa2, NEG N/A Defense: services $28 RCAmerican Energy - Permian Basin, LLC Caa3-PD Caa3, NEG SGL-4 Energy: oil & gas - E&P American Energy - Woodford, LLC Caa2-PD Caa2, STA SGL-3 Energy: oil & gas - E&P American Gilsonite Holding Company Caa2-PD Caa2, NEG N/A Chemicals: Specialty Chemical Arch Coal, Inc. Caa3-PD Caa3, NEG SGL-3 ENERGY: COAL Ascent Resources - Marcellus LLC Caa2-PD Caa2, NEG SGL-4 Energy: oil & gas - E&P Aspect Software, Inc. Caa2-PD Caa2, NEG N/A Technology: Software $551 BCF $270 BondAssociated Materials, LLC Caa3-PD Caa3, STA N/A Manufacturing: Finished Products $830 BondAurora Diagnostics Holdings, LLC Caa2-PD Caa2, STA SGL-3 Services: Consumer Autoparts Holdings Limited Caa2-PD Caa2, NEG N/A Automotive : Parts Claire's Stores, Inc. Caa2-PD Caa2, STA SGL-4 Retail: Department Stores $375 RC,

BondComstock Resources, Inc. Caa2-PD Caa2, NEG SGL-3 Energy: oil & gas - E&P Constellation Enterprises, LLC Caa3-PD Caa3, NEG N/A Manufacturing: Components- $170 Bond CORE Entertainment Inc. D-PD Ca, NEG N/A Media: Cable TV & Television Networks $200 TLCorporate Risk Holdings, LLC. Caa3-PD Caa2, STA N/A Services: Business Denver Parent Corporation Ca-PD Ca, NEG SGL-4 Energy: oil & gas - E&P Dex Media, Inc. Ca-PD Ca, NEG SGL-4 Media Publishing: Books $614 TL DynCorp International Inc. Caa2-PD Caa2, NEG SGL-4 Aircraft & Aerospace: Services $187 TL $455 BondEnergy XXI Gulf Coast, Inc. Caa3-PD Caa3, NEG SGL-4 Energy: oil & gas - E&P $746 BondEuramax International, Inc. Caa2-PD Caa2, STA N/A Manufacturing: Component EXCO Resources, Inc. Caa2-PD Caa2, STA SGL-4 Energy: oil & gas - E&P Goodrich Petroleum Corporation Caa3-PD Caa3, NEG SGL-4 Energy: oil & gas - E&P Halcon Resources Corporation Caa2-PD Caa2, STA SGL-3 Energy: oil & gas - E&P Horsehead Holding Corp. Caa2-PD Caa2, NEG SGL-4 Metals & Mining: Steel & Speciality Metals $205 BondiHeartCommunications, Inc. Caa3-PD Caa2, STA SGL-3 Media: Broadcast TV & Radio Stations $193 Bond ION Geophysical Corporation Caa2-PD Caa2, NEG SGL-4 Energy: Oil Services Iracore International Holdings, Inc. Caa2-PD Caa2, NEG SGL-4 Energy: Oil Services IronGate Energy Services, LLC Caa2-PD Caa2, NEG SGL-4 Energy: Oil Services Isola USA Corp. Caa2-PD Caa2, NEG N/A Technology: Contract Mfg Key Energy Services, Inc. Caa2-PD Caa2, NEG SGL-4 Energy: Oil Services - Drilling Kratos Defense & Security Solutions, Inc. Caa2-PD Caa2, STA SGL-3 Energy: Oil Services LBI Media, Inc. Caa2-PD Caa2, NEG N/A Media: Broadcast TV & Radio Stations Liberty Tire Recycling Holdco, LLC Caa2-PD Caa2, STA N/A Environment: Waste Management Linn Energy, LLC Caa2-PD Caa1, NEG SGL-3 Energy: oil & gas - E&P Logan's Roadhouse Inc. Caa3-PD Caa3, NEG SGL-4 Restaurants: Family Dining $144 BondMashantucket (Western) Pequot Tribe, CT Ca-PD Ca, NEG N/A Gaming: Casinos $16 BCF MD America Energy, LLC Caa2-PD Caa2, POS SGL-3 Energy: oil & gas - E&P NGPL PipeCo. LLC Caa2-PD Caa2, NEG SGL-4 Energy: Gas - Transmission Paragon Offshore plc Ca-PD Ca, NEG SGL-4 Energy: Oil Services - Drilling Peabody Energy Corporation Caa3-PD Caa3, NEG SGL-3 Energy: Coal Penn Virginia Corporation Caa3-PD Caa3, NEG SGL-4 Energy: oil & gas - E&P Preferred Proppants, LLC Caa2-PD Caa2, STA N/A Manufacturing: Building Materials



Production Resource Group, Inc. Caa2-PD Caa2, NEG N/A Services: Business ProPetro Services, Inc. Caa2-PD Caa2, NEG SGL-4 Energy: Oil Services PTC Group Holdings Corp. Caa2-PD Caa2, NEG N/A Metals & Mining: Steel & Speciality Metals $70 TL Restaurant Holding Company, LLC Caa2-PD Caa2, STA N/A Restaurants: Family Dining RGIS Services, LLC Caa2-PD Caa1, NEG N/A Services: Business $5 TL $576 BCFSandRidge Energy, Inc. Caa2-PD Caa2, STA SGL-2 Energy: oil & gas - E&P Sequa Corporation Caa2-PD Caa2, NEG N/A Aircraft & Aerospace: Equipment $1,818 BCF,

BondSFX Entertainment, Inc. Caa3-PD Caa3, NEG SGL-4 Technology Services: Transaction Processors Sheridan Investment Partners I, LLC Caa3-PD Caa3, NEG N/A Energy: oil & gas - E&P Sheridan Investment Partners II, LP Caa3-PD Caa3, NEG N/A Energy: oil & gas - E&P Sheridan Production Partners I-A, LP Caa3-PD Caa3, NEG N/A Energy: oil & gas - E&P Sheridan Production Partners II-A, LP Caa3-PD Caa3, NEG N/A Energy: oil & gas - E&P Sheridan Production Partners II-M, LP Caa3-PD Caa3, NEG N/A Energy: oil & gas - E&P Sheridan Production Partners I-M, LP Caa3-PD Caa3, NEG N/A Energy: oil & gas - E&P Sidewinder Drilling Inc. Caa3-PD Caa3, NEG SGL-4 Energy: Oil Services - Drilling Sierra Hamilton LLC Caa3-PD Caa3, NEG N/A Energy: Oil Services Smile Brands Group Inc. Caa2-PD Caa2, NEG N/A Services: Consumer Sprint Industrial Holdings, LLC Caa2-PD Caa2, NEG N/A Services: Rental Services Stafford Logistics, Inc. Caa2-PD Caa1, STA N/A Environment: Waste Management Stallion Oilfield Holdings, Inc. Caa2-PD Caa1, NEG N/A Energy: Oil Services Swift Energy Company Ca-PD Caa3, NEG SGL-4 Energy: oil & gas - E&P $250 BondThings Remembered, Inc. Caa2-PD Caa1, NEG N/A RETAIL: SPECIALTY $30 RCTransworld Systems, Inc. Caa2-PD Caa2, NEG N/A Services: Business UCI INTERNATIONAL, LLC Caa3-PD Caa3, STA N/A Automotive: Parts Valitas Health Services, Inc. Caa3-PD Caa3, NEG N/A Services: Consumer $75 RC $225 TLVerso Paper Holdings LLC Caa2-PD Caa2, NEG SGL-4 Forest Products: Pulp & Paper $41 Bond $200 RCTunica-Biloxi Gaming Authority D-PD Ca, NEG N/A Gaming: Casinos Warren Resources, Inc. Ca-PD Ca, NEG SGL-4 Energy: oil & gas - E&P Wilton Brands LLC Caa2-PD Caa1, STA N/A Consumer Products: Household & Personal

Care

Wise Metals Intermediate Holdings LLC Caa2-PD Caa2, NEG N/A Metals & Mining: Steel & Speciality Metals

Data as of January 1, 2016. For more analysis of companies with low PD rating, please see Moody's B3 Negative and Lower Corporate Ratings List. E&P is exploration and production; 2016and 2017 columns are $ maturities in millions based on Moody's upcoming annual speculative-grade maturity study: RC is revolver commitment, TL is term loan, BCF is RC and TL.Source: Moody's Investors Service



Appendix AMoody’s Definition of DefaultMoody’s definition of default is applicable only to debt or debt-like obligations (e.g., swap agreements). Four events constitute a debtdefault under Moody’s definition:

1. a missed or delayed disbursement of a contractually obligated interest or principal payment (excluding missed payments curedwithin a contractually allowed grace period), as defined in credit agreements and indentures;

2. a bankruptcy filing or legal receivership by the debt issuer or obligor that will likely cause a miss or delay in future contractuallyobligated debt-service payments;

3. a distressed exchange whereby 1) an obligor offers creditors a new or restructured debt, or a new package of securities, cash orassets that amount to a diminished financial obligation relative to the original obligation and 2) the exchange has the effect ofallowing the obligor to avoid a bankruptcy or payment default in the future; or

4. a change in the payment terms of a credit agreement or indenture imposed by the sovereign that results in a diminished financialobligation, such as a forced currency redenomination (imposed by the debtor, himself, or the sovereign) or a forced change in someother aspect of the original promise, such as indexation or maturity.

Moody’s definition of default does not include so-called “technical defaults,” such as maximum leverage or minimum debt coverageviolations, unless the obligor fails to cure the violation and fails to honor the resulting debt acceleration, if this is required. Alsoexcluded are payments owed on long-term debt obligations that have been missed because of purely technical or administrative errorsthat are 1) not related to the ability or willingness to make the payments and 2) are cured in very short order (typically, one to twobusiness days). Finally, in select instances, based on the facts and circumstances, missed payments on financial contracts or claims maybe excluded if they are the result of legal disputes about the validity of those claims.



Moody's Related ResearchSpecial Comments and Sector In-Depth Reports:

» Leveraged Finance Interest - North American Edition, January 2016 (187109)

» SGL Monitor: LSI Gains Point to Rising Default Risks as 2016 Gets Underway, January 2016 (187113)

» Moody's Fourth Quarter Leveraged Finance Teleconference: Market Outlook & Credit Conditions for 2016, December 2015 (186727)

» Moody's B3 Negative and Lower Corporate Ratings List: Oil & Gas Sends List to Six-Year High, Fueling Forecast for More Defaults, January 2016

(1012945)

» North American Covenant Quality Index: Bond Covenant Quality Worsens in December Amid Limited Issuance, January 2016 (1011395)

» Global Oil and Natural Gas Industry: Increased Supply and Concerns About Demand Growth Drive Prices Yet Lower, January 2016 (1014345)

» Growing Stress in Commodity Sectors Is a Credit Hazard for 2016, December 2015 (1009103)

» Independent Exploration and Production - North America: Reductions in Borrowing Bases Will Strain Liquidity, October 2015 (1008600)

» US Corporate Defaults & Recoveries - Oil and Gas: The Bad, Ugly and Good, May 2015 (1004376)

» EBITDA: Used and Abused, November 2014 (173806)

» Default and Recovery: When LBO Companies Default, Recoveries and Close to Average, July 2014 (169932)

» Covenant-Lite Defaults and Recoveries: Time is Catching Up with Covenant-Lite, June 2014 (171570)

» US Private Equity - Tracking the Largest Sponsors: Defaults Contained in the Recession But Downgrades Continue Long After, June 2014 (170039)

» Annual Default Study: Corporate Default and Recovery Rates, 1920-2014, March 2015 (179348)

» Refunding Risk and Needs 2015-2019: US Speculative-Grade Corporations – Record Maturities Due in 2019; New Issuance Wave Likely in 2017, February

2015 (179022)

» Corporate Default and Recoveries - US: What May Happen in the Next Default Cycle Given Falling Credit Quality, August 2015 (1004664)

» Still Second Rate: LGD assessments point to low recoveries for defaulted second liens, January 2014 (162050)

» US Corporate Default and Recoveries: Lessons from 25 Years of ‘Chapter 22’, December 2012 (147863)

» Moody's Ultimate Recovery Database: Lessons from 1,000 Corporate Defaults, November 2011 (137405)

Default Report:

» Monthly Default Report, December 2015 (1013566)

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of thisreport and that more recent reports may be available. All research may not be available to all clients.

https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_187109
























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REPORT NUMBER 1014695

default rate to reach six-year high in 2016default rate to reach six-year high in 2016 » we project...

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