S&P: 18 weakest links still vulnerable to default on $6.9 billion of debt at the end of April

By Caroline Salls

Pittsburgh, May 12 - A total of 18 Standard & Poor's-rated weakest links remained vulnerable to default on rated debt worth $6.9 billion as of May 10, two more than in April but two fewer than the average recorded over full-year 2005, according to a Friday report.

U.S.-based issuers, including tax havens, constituted 17 of 18 weakest link issuers.

As defaults inch higher, S&P said spreads should begin to increase as well. A simple link between default rates and speculative-grade spreads suggests that if the default rate climbs as expected, then speculative-grade spreads should be hovering at about 427 basis points by the end of April 2007 compared with 325 bps seen at the end of April 2006.

S&P said this would bring spreads more in line with their median range since 2003, and bond spreads on speculative-grade issues have already improved from their record lows, even though spreads remain narrower than their April-May highs.

In the United States, the proportion of lower-grade issuance rose to 49% for the four months ended in April, from 40% in March. The ratio had averaged 44% for full-year 2005, 47% in 2004 and 30% in 2003.

Meanwhile in Europe, for the four months ended April 30, the proportion of lower-grade issuance was 35%, from 39% in full-year 2005 and 45% in full-year 2004.

S&P said the ratio has remained at more than 30% for 10 consecutive quarters in Europe and has remained higher than 30% for 11 quarters in the United States.

According to S&P, the decline in the speculative-grade default rate has been accompanied by a visible easing of lending conditions, especially in the United States, as reported in the Federal Reserve Loan Officer Opinion Survey on Bank Lending Practices.

In the January survey, an 11% greater net percentage of domestic banks reported easing standards for large and midsize firms - up from 9% in the October 2005 survey. Among small firms, the net percentage of banks reporting easing standards increased to 7% in January from 5% in October.

Furthermore, S&P said 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 bps - appears to have bottomed out in 2006, as the distress ratio was 4.3% at the end of April, which is less than the 6.2% average for full-year 2005.

Telecom, auto, consumer products, retail weakest

Weakness was concentrated in the telecommunications, automotive, consumer products and retail/restaurant sectors, which together make up more than 65% of the total number of distressed issues.

Default rates in the U.S. leveraged loan market have declined to a seven-month low, with the default rate falling to 1.53% at the end of April from 2.08% a month earlier, as reported by Standard & Poor's Leveraged Commentary and Data.

S&P said default rates still remain well below the long-term historical average of 3.56% based on the number of loans.

Defaults in the next 12 months are expected to remain below average in this segment, with expectations that it will remain largely in check for the remainder of 2006. Longer 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.

Results from a newly unveiled model indicate that default rate for U.S. leveraged loans will increase to 1.90% by April 2007.

Since the last edition of S&P's weakest links report, three entities were removed from the list and five issuers were added.

The removals were the result of the revision of the CreditWatch status of the ratings on Premier Entertainment Biloxi LLC, Luxfer Holdings plc and Tembec Inc.

Meanwhile, Duane Reade Inc., Primus Telecommunications Group Inc., Werner Holding Co. (DE) Inc., Ziff Davis Media Inc. and Sea Containers Ltd. were added to the list because of downgrades.

With three issuers each, the media and entertainment and the forest products and building materials sectors showed the highest vulnerability to default among the weakest links, each comprising 16.7% of the issuers on the most recent weakest links list.

Next in line were the automotive; chemicals, packaging, and environmental services; retail and restaurants and consumer products sectors, with two issuers each.

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