S&P report: Rise in distressed credits may lead to increase in defaults

By Jennifer Chiou

New York, May 26 - The U.S. bond market could begin to experience a rise in defaults as the number of distressed credits escalates, according to a Standard & Poor's Ratings Services report published Thursday.

The article titled "U.S. Distressed Supply Builds" said the factors that contributed to bullishness in prior years - low inflation, surging corporate profitability and an accommodative monetary policy - are now poised to weaken from previous levels.

"Continued volatility in the bond market could create pressure points for distressed credits that have substantially benefited from benign financing conditions," said Diane Vazza, head of S&P's Global Fixed Income Research Group. (Distressed credits are defined as speculative-grade issues that have option-adjusted spreads of more than 1,000 basis points.)

At-risk sectors, such as automotive, chemicals, packaging and environmental services and high technology, saw an increase in their share of total distressed credits by May 16, the S&P assessment said.

"A rising distressed ratio would signal increased urgent need for capital by those most in need and potentially act as a precursor to higher defaults, if accompanied by a credit crunch," Vazza added.

The report shows the transportation and telecommunications sectors have been most vulnerable, together accounting for nearly 40% of distressed issues.

In contrast, banks, brokerages and utilities sectors did not have issues trading in the distressed range during the same period.

Over the long term, movements in the distressed ratio correspond well with trends in the speculative-grade default rate, with a peak in the distressed ratio generally signaling a peak in default rates a year later, the report stated.

As expected, CCC-, CCC and CCC+ ratings accounted for the majority of distressed credits, though some issues in the high technology and utilities sectors with BBB-category rankings also had trading spreads in excess of 1,000 bps.

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