S&P: high-yield market begins to stabilize despite risks

Standard & Poor's said in a report that volatility peaked in mid-August and appears to be retreating after the Federal Reserve cut the funds target rate by 50 basis points on Sept. 18.

The VIX fell below 20 on Sept. 19 for the first time since July 26, according to S&P. In response to less volatility and easier money, spreads have eased to 413 bps on Sept. 26 from 446 bps before the rate cut.

"The high-yield primary market, which was stagnant in August and early September, is beginning to see some new deals, and investors have begun to absorb some of the supply overhang that has clogged the new deal flow," Diane Vazza, head of S&P's global fixed-income research group, said in a written statement.

"As the market begins to move past the recent disruption, we expect spreads will settle, albeit at a higher level than in June," Vazza said.

Leverage-loan issuance was $66.6 billion in June, compared with just $3.6 billion in August. With more than $300 billion in unsold deals, the primary market in the late fall and early winter is expected to be much more vibrant, S&P said.

"Defaults have been slow to materialize this year, though risks are on the rise for 2008, judging by the sharp acceleration in the number of firms trading at distressed levels," Vazza said.

If the economy slows as forecast, profit pressure will add stress to firms at the bottom of the ratings scale, Vazza said.

"If credit market conditions worsen, firms may be hard-pressed to roll over debt, which will not bode well given the high-leverage multiples among many speculative-grade issuers," Vazza said. "We are currently holding our speculative-grade default forecast at 1.4% by year-end 2007, based on the assumption that borrower-friendly terms will stave off a material increase in defaults until 2008."

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