Fitch sees 15%-18% junk defaults by year end, little relief in 2010

By Paul Deckelman

New York, June 10 - The high yield default rate - already well above where it stood a year ago and where it ended last year - is going to continue climbing for the remainder of this year, even if the economy improves, a senior official of the Fitch ratings service warned Wednesday, predicting that the measure of economic distress would be in a 15% to 18% range by year's end. The agency also believes that the default rate will remain elevated "well into 2010."

Even though junk market conditions are "better off today than earlier this year," said Mariarosa Verde, the managing director for Fitch Credit Market Research, the parade of defaults continues unabated, with the rate now standing at 9.2% -- several times its year-ago level of 1.2% -- and showing no signs of stopping as it heads upward, with the massive default arising from General Motors Corp.'s bankruptcy filing on June 1, and other company defaults sure to push that rate higher still.

"Defaults will continue at the current pace through at least the year's end," she cautioned. "We are not likely to see any deceleration in defaults, even in 2010, even if the pace of economic activity improves."

Verde told attendees at the New York Society of Security Analysts' 19th Annual High Yield Bond Conference that including the GM bankruptcy, defaults since the credit downturn began last year have already totaled some $110 billion of debt - matching the previous record set during the market downturn caused by the recession of 2002, with no end in sight.

Verde opined that "even with the telecommunications meltdown" that constituted a large portion of the defaults during that 2002 slide, "that last recession was probably a cream puff compared to this one."

She said that "in at least 20 years, we've never recorded such a dramatic and rapid surge in downgrades as we have in the past six months." And not only have those downgrades "been abundant, but they have also been severe," many of them lowering companies' credit by more than the usual just one notch.

$522 billion downgrades

The Fitch official said the deterioration in companies' credit quality was by no means limited to the junk precincts.

"Even at the investment-grade level," she said, "revenue and profitability in the last quarter sort of dropped off a cliff. In the entire U.S. corporate bond universe last year, stretching across all ratings categories, downgrades were leveled against nearly $900 billion principal amount of paper, affecting 24% of the market. In just the first quarter alone of this year, there have been an additional $522 billion worth of downgrades, constituting 14.6% of the total par value of those bonds.

Sector trouble spots last year included building materials, which saw 51.7% of its companies' bonds downgraded, followed by banking and finance (41.1%), gaming, lodging and restaurants (38.3%), automotive (28%), and leisure and entertainment (23%). This year's problem areas, judging by those first-quarter defaults, include textiles and furniture (38.7%), gaming, lodging and restaurants (29.1%), insurance (24.2%), banking and finance (24.1%) and cable - which saw no downgrades at all last year - (16.2%).

Many of those same sectors, she said, also dominate the list of sectors having a strong negative ratings bias, in view of outlooks - automotive, building and construction, retail, leisure and lodging, transportation and consumer products, "all of the ones you would expect."

Cable leads defaults

In terms of actual defaults so far this year, media - specifically, the cable sector ($12.6 billion, or 16.4%) and broadcasting and other media ($12 billion, 12.5%), - automotive ($11.3 billion, 14.7%) , paper and containers ($8.5 billion, 11%), gaming lodging and restaurants ($8.4 billion, 10.9%) and computer and electronics makers ($5.6 billion, 7.2%) - lead the sector-by-sector list of cumulative defaults.

Defaults, Verde said "affect many different sectors, showing the length and breadth of this downturn."

She said large defaults account for much of those totals, including Charter Communications Inc. (cable), GM (autos), AbitibiBowater Inc. and Smurfit-Stone Container Corp. (containers), Harrah's Entertainment Inc. and Station Casinos Inc. (gaming) and Freescale Semiconductors Inc. (computers/electronics).

However, some sectors seemed almost bulletproof, among them metals and mining, leisure and entertainment, banking and finance and food, beverage and tobacco - none of them with more than $500 million of defaulted paper, and most considerably below that, and all with percentage figures less than 1%.

24.4% recovery rate

While defaults are mounting, Verde said, recovery values on defaulted debt is going the other way. While recovery rates peaked at respectable levels in the relatively low-default period from 2004 through 2007 - 61.5% in 2004, 57.6% in 2005, 64.3% in 2006 and as robust 66.4% in 2007, it's been all downhill since then - a 47.9% recovery rate last year as defaults rose to 6.8% from 0.5% in 2007, and a year-to-date rate for this year through April, Verde said, of 24.4%.

She said she "does not expect much improvement" from the May numbers, with GM, in fact, likely to send the May recovery percentages still lower.

She added that "if history is any guide, we will continue to see lower recovery rates in industries with systemic problems," like autos, broadcasting and cable."

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