S&P: U.S. default rate will catapult to all-time high of 13.9% by year-end

By Caroline Salls

Pittsburgh, Jan. 22 - Standard & Poor's now expects the U.S. corporate speculative-grade default rate to catapult to an all-time high of 13.9% by December 2009, according to a report released Thursday.

S&P said this forecast represents a sizeable increase from the 7.6% rate it projected following the third quarter of 2008 and is "based on a substantial worsening of the economy and the financial environment."

The agency said the baseline projection of 13.9% would result in an unprecedented trough-to-peak increase of almost 13%, outstripping the rate of increase observed in any previous default rate cycle since the start of S&P's series in 1981.

To realize the baseline projection of 13.9%, S&P said 209 issuers must default in the next 12 months, for an average of 17.4 defaults per month and 52.2 defaults per quarter, more than double the corresponding 2008 pace of 7.8 and 23.5 defaults, respectively.

Under its two alternative economic scenarios, S&P said the pessimistic scenario yields a catastrophic mean corporate default rate of 18.5%, and the optimistic scenario yields an average corporate default rate of 10.0%.

In the next 12 months, 278 defaults are required to reach the pessimistic default rate forecast of 18.5% and there must be 150 defaults to reach the optimistic forecast of 10.0%.

According to the report, the year will be marked by greater differentiation on the basis of risk, which implies that funding will be rationed toward more creditworthy borrowers at the expense of those at the lowest end of the credit spectrum.

"The continued high stress level in the financial system - which has wrought changes unprecedented since the Great Depression - is expected to ripple through more broadly, materially affecting the number of defaults," S&P said in the report.

"Although aggressive government intervention in the U.S. and elsewhere has somewhat countered the turmoil, we now expect it to take its toll on already vulnerable corporations and the economy in general."

S&P said a higher-than-normal level of volatility is associated with the default forecast, and risk factors include future changes in government policy on both monetary and fiscal fronts and government's effectiveness in arresting the vicious circle of financial gridlock, earnings disappointments and punctured confidence.

The risk factors also include responsiveness of credit and financing channels to these rehabilitative strategies and the return of liquidity and private capital to the corporate and consumer sectors; the depth and duration of the ongoing economic recession; and the timing of housing-market stabilization.

The agency did say that its baseline expectation remains that a gradual lift from expected fiscal and monetary measures will slowly restore financial stability and lower economic pressure, helping in turn to tone down the volume of defaults.

U.S. defaults jump

S&P said the number of corporate casualties in the United States rose sharply in 2008 to 94 issuers, nearly six times the number recorded a year earlier and the highest number of defaults since 2002 when defaults reached 129 issuers.

In addition, S&P said December's total of 17 defaulters constituted the maximum recorded in any month of 2008 and the highest monthly tally since December 2001 when the same number of issuers defaulted.

Expressed as a share of the rated universe, S&P said the U.S. corporate speculative-grade default rate finished the year at 4.02%, a fourfold increase from the 25-year low of 0.98% in 2007.

Of the 125 global defaults recorded in 2008 on debt worth $429.6 billion, the agency said 94 were based in the United States and affected debt worth $334.3 billion.

At $176.8 billion, S&P said investment-grade rated financials Lehman Brothers, Washington Mutual and IndyMac Bank were responsible for more than half the debt affected by U.S. defaults.

Meanwhile, S&P said defaults from the speculative-grade segment accounted for $150.2 billion last year, and the par-based default rate for the U.S. speculative-grade segment increased to 15.0% based on an estimated total outstanding U.S. high-yield volume of about $1 trillion.

The agency said the U.S. default rate still failed to pierce the 4.34% long-term 1981-to-2008 average for the 56th consecutive month.

The corporate speculative-grade default rates at the end of 2008 were 2.54% in Europe, 1.96% in the emerging markets and 3.43% globally.

If investment-grade rated entities are also included, S&P said the trailing 12-month issuer-based U.S. corporate default rate was 2.41% at the end of 2008 compared with 1.69% globally, 0.53% in Europe and 1.21% in the emerging markets.

Given the sharp hit to consumers in this slowdown, S&P said it expects the consumer discretionary sector to be at the forefront of the default wave, as this segment accounts for a considerable portion of the distress credits and nearly half the issuers listed as weakest links.

Leveraged loans

For U.S. leveraged loans, S&P said the 12-month-trailing default rate increased to a 57-month high of 4.35% in December from 3.32% in September and 0.26% 12 months earlier.

Also, the loan distress ratio, defined as the percent of performing loans trading below 80 cents on the dollar, catapulted up to 87.5% at the end of December from 78.9% in September and 13.4% a year ago.

Weakest links

As of Jan. 16, S&P said a preliminary count indicated that 186 U.S.-based issuers were vulnerable to default on combined rated debt worth $342.1 billion, up from 174 at year-end 2008.

S&P said the number of weakest links, defined as entities rated B- or lower with a negative outlook and therefore closest to the default threshold, has increased markedly from just 78 at the end of 2007 and a near 10-year low of 64 entities in July 2007.

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