Moody’s Downgrades American Apparel

Cites covenant violations of Capital One credit facility in third quarter.

Moody’s Investors Service on Tuesday lowered American Apparel Inc.’s credit rating a single notch, to “Caa2” from “Caa1,” after the Los Angeles-based vertical retailer fell out of compliance with covenants of its credit facility with Capital One during the third quarter.

The rating outlook is negative.

The “Caa2” designation is eight notches below investment grade. Instruments carrying the “Caa” label are considered to be “subject to very high credit risk.”

American Apparel failed to comply with the fixed charge coverage and maximum leverage ratio requirements of its $50 million asset-based revolving credit agreement with Capital One as its adjusted earnings before interest, taxes, depreciation and amortization fell 71.6 percent in the third quarter to $3.8 million. Much of the decline was attributed to the firm’s difficulties making the transition to a new distribution center.

Although Capital One granted American Apparel a waiver for the period, the retailer said it doesn’t expect to be in compliance with the terms of the facility until after the third quarter of 2014. American Apparel acknowledged that it couldn’t give assurance that further waiver arrangements can be made with its lender.

“The negative outlook reflects uncertainty surrounding American Apparel’s ability to obtain future waivers of its financial maintenance covenants, which would be necessary to avoid an event of default under its existing debt agreements,” wrote Moody’s senior analyst Charles O’Shea.

The waiver agreement included an increase of 1 percent in the interest rate paid to Capital One and limitations on borrowing capacity.

The firm’s net loss in the quarter was reduced, to $1.5 million from $19 million, while sales inched up 1.5 percent to $164.5 million.