Fitch: European high-yield default rates to rise in 2006 after two-year record low of 0.5%

By Caroline Salls

Pittsburgh, Jan. 18 - Fitch Ratings said default rates in the European high-yield market are set to rise in 2006 based on the large number of acquisition-related debt issues throughout 2004 and 2005, the 17% share of CCC-rated deals in 2005 and increased refinancing risk due to back-ended amortization profiles and potential interest rate rises, according to a news release.

Fitch said default rates remained at the record low of 0.5% for the second consecutive year in 2005. Specifically, only three issuers defaulted on €713 million of par value, compared with 0.5% on one €580.5 million par value default in 2004.

The agency said it believes the current low default rate is the result of technical factors and a generally benign economic and credit environment.

According to the release, moderate but stable economic growth and particularly strong liquidity in the banking and capital markets were again favorable to European high-yield issuers and helped them weather the negative effect of increasing energy and raw material prices in 2005.

Despite general trends, Fitch said several sectors in the credit markets encountered negative pressure, notably consumer-related sectors, non-food retailers and automotive suppliers.

Fitch noted that the trend towards leveraged buyout recapitalizations in 2004 and 2005 has mitigated amortization pressure on transactions originally arranged in 2002 and 2003.

U.S. power supplier Calpine Canada Energy Finance defaulted on its two European senior unsecured bond obligations following the company's filing of Chapter 11 bankruptcy in December, following the defaults of U.S. auto parts supplier RJ Tower Corp. and Swedish bus operator Concordia Bus in early 2005.

Including Calpine's €143 million and £200m senior unsecured notes, the par value of European high-yield defaults totaled €713m or 0.5% in 2005.

The time to default was similar for all defaulted issues in 2005, averaging 4.6 years, compared with 2.7 years in 2004, 2.9 years in 2003 and 2.6 years in 2002.

The average recovery rate of 56% at year-end 2005, based on the three defaults, remained well below the unusually high 95.8%, based on the sole default in 2004, but is still higher than the 11% in 2001, 15% in 2002 and 24% in 2003 that were influenced by the large number of telecoms and cable defaults, Fitch said.

In 2005, the total market volume for speculative-grade bonds increased by 46% to €143.3 billion from €98 billion in 2004.

Fitch said the increase was driven by the €41.9 billion of fallen angels entering the speculative-grade arena, primarily issued by General Motors, General Motors Acceptance and Ford Motor Credit Co.

The percentage of bonds rated CCC and below within the total high-yield market decreased to 9.5% in 2005 after increasing to 12.5% at the end of 2004, while the concentration of BB-rated bonds increased to 60.8% from 44.1% at the end of 2004.

However, excluding the bond volume attributed to fallen angels, the concentration of CCC to C-rated bonds increased to 13.5%, while the percentage of BB-rated bonds was virtually unchanged from the previous year at 44.6%.

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