S&P: Global corporate default rate hits eight-year low of 1.40%

By Caroline Salls

Pittsburgh, Dec. 6 - The global corporate speculative-grade bond default rate slipped to a new eight-year low of 1.40% for the 12 months ending in November, a sizable drop from the 1.60% default rate reported one month ago, according to a Standard & Poor's report.

According to the report, the speculative-grade default rate has remained below the long-term 1981 to 2004 average of 4.96% for 24 consecutive months, but is still higher than the record low of 1.28% posted in the second quarter of 1997.

"The global default rate is expected to edge up slowly from its trough before the end of 2005," S&P's Diane Vazza said in the release.

"In the United States, the trailing three-month default rate has been edging up since July, but dropped in the most recent month."

Results from a proprietary default forecast model indicate that U.S. speculative-grade default rates will continue to edge up slowly in the next few quarters, reaching 2.8% by the third quarter of 2006, S&P said.

The 2.5% average forecast for the next four quarters, however, is slightly higher than the historical 2.1% average of the trailing four quarters, according to the report.

Weakest links

As of Dec. 6, S&P said a total of 18 entities remained vulnerable to default on rated debt worth $23.3 billion, which is one more than a month earlier, but lower than the average of 30 entities recorded over full-year 2004.

U.S.-based issuers constituted 14 of the 18 weakest-link issuers, which are defined as issuers rated CCC or lower with either a negative outlook or ratings on CreditWatch negative.

Since October, two entities were removed from the list and three issuers were added.

The removals were the result of the default by U.S.-based FLYi Inc. and a favorable revision to the CreditWatch status of Bally Total Fitness Holding Corp. Meanwhile, Calpine Corp., Integrated Electrical Services Inc. and Pliant Corp. - all U.S.-based companies - were added to the weakest links list as a result of downgrades.

The dramatic increase in the debt amount associated with this month's weakest links is due to the downgrade of Calpine, which has about $18 billion of total debt outstanding.

S&P said Calpine's ratings downgrade is based on the Dec. 2 unfavorable court decision, which may require it to return $313 million to the trustee account by Jan. 20. According to S&P, this development could materially harm the company's weak liquidity condition.

With four issuers, the media and entertainment sector showed the highest vulnerability to default among the weakest links, making up 22% of issuers on the most recent weakest links list. Next in line was the chemicals, packaging and environmental services sector with two issuers.

S&P said the introduction of a new bankruptcy regime in the United States in mid- October appears not to have caused a material increase in defaults among corporate borrowers.

However, S&P said bond spreads on speculative-grade issues have turned around from their record lows, even though spreads are still narrower than their April to May highs.

In the United States and Europe, S&P said a rising proportion of lower-grade issuance (B- or lower as a share of total speculative-grade issuance) beginning in 2003 serves as an early warning of renewed default pressure within two years.

Although the proportion of lower-grade issuance in the latest three months slipped to 36%, the ratings agency reported year to date the ratio in the United States remains high at 41% compared with 43% on average in 2004.

At 40%, the proportion of lower-grade issuance was also high in Europe in the year thus far. Although slightly slower than the 45% pace set in 2004, it has remained at more than 30% for eight consecutive quarters.

Lending conditions easing

S&P said the decline in the speculative-grade default rate has been accompanied by a visible easing of lending conditions, especially in the United States, as reported in the Federal Reserve Loan Officer Opinion Survey on Bank Lending Practices.

In the latest survey, conducted in October, a 9% net percentage of domestic banks reported easing standards for large and midsize firms, down from 17% in the July survey.

Furthermore, S&P said the proportion of distressed credits in the United States, defined as speculative-grade-rated issues that have option-adjusted spreads of more than 1,000 basis points, declined in 2003 and appears to have bottomed out in 2004 and the majority of 2005.

The distress ratio was reported at 6.0% at the end of November, which is less than the 7.0% average for full-year 2004. Weakness was centered in the automotive, telecommunications and consumer products sectors, which together account for more than 50% of the total number of distressed issues.

Default rates in the U.S. leveraged loan market have also remained muted, according to S&P, reaching 1.65% at the end of November compared with 1.12% at year-end 2004.

S&P said it expects defaults in the next 12 months to remain benign in this segment, with default rates sliding back to 1.26% by November 2006, according to a proprietary model.

European default rate low at 0.57%

European speculative-grade default rates remained low at 0.57% at the end of November versus 1.23% 12 months earlier. In the emerging markets, a 0.43% default rate was recorded at the end of November versus 0.91% six months earlier.

Two defaults in emerging markets have been observed in the trailing 12 months, OAO NK Yukos of Russia and Administracion Nacional De Combustibles Alcohol Y Portland of Uruguay.

In the United States, the highest default rates by industry in the trailing 12 months were recorded in the transportation sector.

In the first 11 months of 2005, 35 defaults have been recorded, affecting rated debt worth $32.6 billion compared with a total of 49 defaults in full-year 2004 affecting debt outstanding worth $16.2 billion.

In November, the only recorded U.S.-based default was FLYi Inc. The default follows the company's filing for Chapter 11 bankruptcy protection on Nov. 7.

Of the total recorded in the year to date, the United States recorded 30 defaults affecting rated debt worth $32.1 billion.

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