S&P forecasts 12-month U.S. junk default rate increase range; March global rate climbs to 1.14%

By Caroline Salls

Pittsburgh, April 23 - Standard & Poor's baseline forecast predicts that there is a 60% probability that the U.S. speculative-grade default rate will escalate to a mean of 4.7% in the 12 months ending March 31, 2009, reflecting the unfolding recessionary conditions, weaker earnings prospects and continued financial pressures that will increase lending constraints.

To reach the baseline forecast of 4.7%, S&P said 75 issuers must default in the next 12 months, for an average of 6.3 defaults per month, which is slightly higher than the 5.3 average in the first quarter of 2008.

S&P said as many as 94 issuers or as few as 58 must default for the rate to fall within the baseline range of 3.6% to 5.9%.

Under a pessimistic scenario, S&P said the 12-month default rate could reach a mean of 8.5%, nearly double the long-term average of 4.4%, but still below the peak in 2001-2002.

Meanwhile, the optimistic scenario yields an average default rate of 3.7%.

In the next 12 months, 136 defaults are required to reach the pessimistic default rate forecast of 8.5% and 59 defaults to reach the optimistic forecast of 3.7%.

Global rate hits 10-month high

The ratings agency also reported Wednesday that the trailing 12-month global corporate speculative-grade default rate reached a 10-month high of 1.14% in March, up from 1.02% in February.

By region, the March speculative-grade default rate was 1.40% in the United States, spiking from 1.22% in February; 0.49% in Europe, a marginal decrease from 0.50% in February; and 0.17% in the emerging markets, down after five consecutive months at 0.18%.

Through the first quarter of 2008, S&P reported that 17 defaults were recorded, compared with only six in the same period last year.

Four additional defaults have been recorded in April, bringing the total to 21 defaults in 2008 affecting debt worth $12.8 billion. The April defaults include Interep National Radio Sales Inc., Vicorp Restaurants Inc., Vertis Inc. and Linens 'n Things Inc.

S&P said the year-to-date total is only one fewer than the 22 recorded in full-year 2007.

According to the report, the United States has led the charge with 16 defaults in the year to date. It also leads in the number of weakest links, defined as issuers rated B- or lower with either a negative outlook or ratings on CreditWatch negative, with 101 entities, or 82.8% of the total.

Weakest links

As of April 15, 122 weakest links globally were vulnerable to default on rated debt worth $102.2 billion.

S&P said the current count of weakest links is the highest in 19 months, and eight more than the number reported in February.

By sector, S&P said media and entertainment, consumer products, and retail/restaurants continued to show the most vulnerability for the 10th consecutive month with the highest concentration of weakest links. This sector accounted for six weakest links, while chemicals, packaging and environmental services accounted for three weakest links.

Since S&P's last report, 12 entities were removed from the list, and 20 were added.

Of the 12 entities removed from the list, four were eliminated because of a revision in their outlook/CreditWatch status, four are no longer rated, and the remaining four defaulted.

Of the 20 new weakest links this month, S&P said 12 entities were added because they were downgraded with no change in their outlook/CreditWatch status, two were added because downgrades were followed by a change in their outlook status, and six were added because their outlooks were revised to negative with no rating change.

All but one addition to this month's list were from the United States.

S&P said it expects to see more defaults within consumer-related sectors like retail/restaurants, where there is a high concentration of weakest links and distressed companies as the economy continues to deteriorate.

In addition, S&P reported that more than 50% of the weakest links were involved in transactions involving private equity.

The agency said this is not surprising, as a deluge of liquidity in the bond and loan markets in recent years has spurred a wave of leveraged activity, including private equity sponsors looking to put "cheap money to work on behalf of their clients."

In the leveraged-loan segment, the ratings agency reported 13 institutional loan issuers' defaults in the first quarter of 2008, compared with just seven defaults during 2006 and 2007.

The 12-month trailing institutional loan default rate increased to a two-year high of 1.83% at the end of March, from 1.50% in February and 0.26% at year-end 2007.

Low-grade debt deals down

Also, S&P reported that the market remains hesitant to absorb low-grade debt, resulting in a significant slowdown in the U.S. issuance pipeline.

As a result, only four speculative-grade deals totaling $2.64 billion came to market in March, significantly lower than the average of 11 deals per month in the second half of 2007 and the average of 38 deals per month in the first half.

In the trailing six months, the share of new issues rated B- and lower as a proportion of total speculative-grade issuance decreased to 45.45% in March from 46.58% in February.

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