Outlook 2013: Rating agencies expect default rate rise in year ahead

By Aleesia Forni

Columbus, Ohio, Dec. 31 - Two major rating agencies expect the speculative-grade default rate to edge higher in 2013, while a third is projecting the rate to remain flat, according to reports provided by the agencies.

Standard & Poor's expects the U.S. corporate trailing 12-month speculative-grade default rate to increase to 3.7% by September 2013 from 3% as of September 2012.

This is lower than the long-term average of 4.5%.

Moody's Investors Service expects the trailing 12-month global speculative-grade default rate to range from 2.3% to 2.9% in 2013, following a November that saw a default rate of 2.7%.

Additionally, the agency believes the default rate will remain at 2.7% to close the year.

Fitch Ratings expects the U.S. high-yield par default rate to hit 2% in 2013, which is in line with 2012 activity.

However, all three agencies point to uncertainty in the market as a factor that could affect the default rate going forward.

Fitch states the risk of "some unforeseen shock that disrupts the fragile economy" could affect this projection, and each agency points to the fiscal cliff as a factor.

Moody's: Defaults to climb

Moody's expects the trailing 12-month global speculative-grade default rate to kick off the year at 2.6% in January, according to the agency's monthly default report.

The agency expects the rate to fall to as low as 2.3% in March before climbing back to 2.9% in November 2013.

In November 2012, the rate came in at 2.7%, down from a revised forecast of 3.1% in October.

Three Moody's-rated corporate issuers defaulted in November, bringing the total to 53.

Meanwhile, the U.S. speculative-grade default rate fell to 3.1% in November from 3.5% in the previous month.

"The decrease was driven mainly by eight defaulters leaving the trailing 12-month window, while only two entered," according to a report.

The rate was higher than last year's 2% U.S. default rate.

Moody's global distressed index, which measures the percentage of issuers having debt trading at distressed levels, stood at 15.1% in November, up from October's 14.7%.

The index was at 24.1% in November 2011.

Few corporate defaults

"Corporate defaults remain few, in keeping with our recent expectations," Moody's November Default Report stated. "We are concerned about the possibility of significant economic and financial disruptions following a fiscal crisis in the U.S.

"Still, if liquidity and funding remain available, our baseline expectation is that corporate default rates will remain below historical averages."

The rate is expected to remain at 2.7% to end the year, "well below" the average of 4.8% since 1983.

Furthermore, Moody's expects default rates to be highest in the media sector in the United States.

The global speculative-grade bond default rate fell to 1.3% in November from 1.9% in October and down from 1.8% in November of 2011.

The U.S. dollar-weighted speculative-grade bond default rate was 0.9% in November after falling from 1.5% in October.

The rate was 1.2% the previous year.

"In the leveraged-loan market, AMF Bowling Worldwide was the sole company which defaulted on rated loans in November," the report stated.

This caused Moody's trailing 12-month US leveraged loan default rate to rise to 2.8% in November from 2.7% in October.

The rate was 0.8% in November 2011.

S&P: Default rate to rise

Standard & Poor's expects the U.S. corporate trailing 12-month speculative-grade default rate to increase to 3.7% by September 2013 from 3% as of September 2012.

This is lower than the long-term average of 4.5%.

In order for this projection to become reality, a total of 58 issuers would need to default in the 12 months ending September 2013.

In comparison, 46 issuers defaulted in the 12 months ended September 2012.

"Our baseline forecast is partly based on the assumptions that U.S. economic growth will continue to be slow and the unemployment rate will remain elevated," the report stated.

"The labor market is improving but at a slow pace."

The Bureau of Labor Statistics reported that 171,000 new jobs were created in October, taking the 2012 total to more than 1.5 million.

"While any new job created is encouraging, the economy still has some ground to make up for the 8.7 million jobs lost in 2008 and 2009," the report stated.

The report also cites the elevated unemployment rate of 7.9%, though S&P expects this to "decline modestly" to 7.5% the end of 2013.

Looking to the long-term, a reversal in investor sentiment could lead to a slowdown in bond issuance.

Along with an increase in borrowing costs, this could result in a considerable increase in defaults, particularly among companies that have yet to refinance.

S&P expects maturing debt to "escalate significantly" in 2013.

"Borrowers vying for capital would likely face increased competition, especially in light of the nearly $800 billion of debt that we expect to mature from investment-grade entities in the same period."

2012 sees few defaults

Defaults in 2012 were "relatively low," with S&P reporting 79 issuers having defaulted in 2012.

Forty-five of the 79 issuers were based in the United States.

Additionally, 22 issuers were in emerging markets, nine in Europe, and three in other developed regions.

"So far this year, missed payments and bankruptcy filings have accounted for 22 defaults each, distressed exchanges have accounted for 16, and 13 are confidential," the report said. "The remaining six entities have defaulted for various other reasons."

Meanwhile, S&P's speculative-grade composite spread tightened 4 bps to 569 bps in December.

The speculative-grade composite spread is below its one-year moving average of 649 bps and its five-year moving average of 759 bps, according to a report.

"We expect continued volatility in the near term, especially in the speculative-grade segment, which could result from both positive and negative factors," the report stated.

However, S&P expects U.S. corporate defaults to stay below the long-term average in the short term.

"On the negative side, an increase in volatility in the financial markets, influenced by weakening economic conditions, could continue to weigh on risky assets," according to the report.

Fitch: Default rate steady

Fitch expects the U.S. high yield par default rate to close the year at 2% and remain there into 2013.

The agency noted, however, that a bankruptcy filing by Energy Future Holdings could move the rate up an additional 1.5% given its large size.

"The leading support for another below-average default year is Fitch's expectation of modestly higher U.S. GDP growth of 2.3% in 2013 combined with relatively good corporate fundamentals and the Federal Reserve's commitment to loose monetary policy," the report stated.

Fitch expects the economy's "mild recovery" to remain steady as well.

The report added that this low default rate should be viewed with caution "as more of a lagging rather than a leading indicator of credit conditions."

As the U.S. economy is bound to the central bank's quantitative easing, an "unforeseen shock" that disrupts the country's fragile recovery poses a risk.

"A catalyst for such an event could range from a further deterioration in the European debt crisis to the looming U.S. fiscal cliff," the agency said, adding that it expects the full impact of the fiscal cliff to be avoided.

Additionally, Fitch believes that some of the conservatism shown in recent years is fading away, which presents a longer-term concern about the direction of credit quality.

"As of mid-December, negative outlooks outnumbered positive outlooks across the universe of Fitch-rated investment grade and speculative grade U.S. industrials," the report stated.

Few surprises in 2012

Fitch reported a default tally of $20.5 billion through mid-December, compared to $15.9 billion for the full year of 2011.

The default rate is expected to close the year at 2%.

Meanwhile, the weighted average recovery rate on defaults through November stood at 48.3% of par.

"There were few surprises in the pool of 2012 defaults," the report stated. "Most involved 'CCC' or lower rated issues trading at distressed prices at the beginning of the year."

The par default rate for these CCC issues was 10% in 2012, and the agency expects a similar default rate from this group in 2013.

"A 2% growth environment is challenging for these issuers even if exceptional funding conditions may have given some of these companies near-term breathing room," according to the report.

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