S&P reports increased 1.18% January junk default rate; 113 weakest links under new criteria

By Caroline Salls

Pittsburgh, Feb. 15 - Standard & Poor's 12-month trailing global corporate speculative-grade bond default rate for January increased to 1.18% from 1.09% in December, according to a Thursday report.

S&P said the global default rate has been below its long-term 1981 to 2006 average of 4.48% for 36 consecutive months.

By region, speculative-grade default rates were recorded at 1.39% in the United States, 2.12% in Europe, 2.0% for Western Europe and 0.38% in emerging markets.

Three defaults were recorded among global corporates rated by S&P, affecting rated debt worth $130 million, including TK Aluminum Ltd., Pacific Lumber Co. and Port Townsend Paper Corp.

As of Feb. 12, S&P said 113 weakest links remained vulnerable to default on combined rated debt worth $94.9 billion.

Beginning in February, S&P expanded the criteria for entities included in the weakest links report to include entities rated B- or lower that have either a negative outlook or ratings on CreditWatch negative. Previously issuers had to have a CCC or lower rating.

Of the 113 weakest links reported as of Feb. 12, 26 would be included using the earlier criteria, one less than the 27 entities reported last month.

For the second consecutive month, S&P said the proportion of high-yield distressed issuers recorded fell to an all-time low of 1.3% in January from 1.6% in December.

The agency said its baseline forecast for 2007 remains that the default rate will edge up slowly from its 2006 trough, ending the year at 2.33%.

S&P said it tested two alternative scenarios, one pessimistic and one optimistic, with varying implications for default rates.

Under the pessimistic scenario, the model anticipates a faster increase in the default rate to 3.52% by the end of 2007, its highest rate in 15 quarters.

In contrast, the optimistic scenario anticipates a modest increase in the 2007 year-end default rate to 1.54%.

Under no scenario did default rates exceed their long-term average of 4.54%.

S&P said the pipeline of low-rated bond issuance remains considerable: deals rated B- or lower accounted for 44.4% of total speculative-grade issuance at the end of January, up from 34.6% a month ago.

In addition, 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, posted an all-time low of 1.3% in January, following December's then record low of 1.6%.

S&P said weakness is concentrated in the health care, retail and restaurants and forest products and building materials sectors, which together constitute 47% of the total number of distressed issues.

Default rates in the U.S. leveraged loan market declined to 0.78% January from 0.79% in December and 1.97% recorded 12 months earlier, and there have been essentially no performing loans in the United States in the past 11 months bid at distressed prices below 80 cents on the dollar.

S&P said default rates remain well below the long-term historical average of 3.3% based on the number of loans, as defaults in the next 12 months are expected to remain below average in this segment and to remain largely in check through the first quarter of 2007.

Over the long term, however, S&P said the increasingly aggressive structures of the new-issue market will leave many issuers vulnerable to default when liquidity dries up.

Weakest links details

Since last month, Pacific Lumber and Port Townsend Paper were removed from the weakest links list because they defaulted, and Wolverine Tube Inc. was removed because of a revision in its Credit Watch listing to positive from negative.

With 23 issuers, the media and entertainment sector showed the highest vulnerability to default among the weakest links, constituting 20.4 % of the issuers on the most recent list.

Next in line were retail/restaurants and consumer products with 13 and 12 issuers, respectively.

S&P said there were three sovereigns included in the list, including the Republic of Bolivia, Republic of Ecuador and Republic of Lebanon.

Geographically, United States-based issuers featured disproportionately on the weakest-links list, accounting for 79.6% of the total, or 90 entities, which S&P said is attributable to the higher ratings penetration in the U.S. marketplace.

Elsewhere, Europe accounted for 7.1% of the total issuers with eight entities.

The agency said the industrial sector was the leading issuer of low-rated issues in January, with deals worth $1.5 billion, following the trend established in 2006.

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