S&P: Global junk bond default rate drops to new eight-year low of 1.28% in March

By Caroline Salls

Pittsburgh, April 10 - The global corporate speculative-grade bond default rate remained at its lowest level in more than eight years, reaching 1.28% for the 12 months ended in March, according to a Standard & Poor's report.

The mark is down from 1.33% in February.

Globally, the speculative-grade default rate has remained below the long-term 1981 to 2005 average of 4.65% for 26 consecutive months and has matched the record low of 1.28% posted in the second quarter of 1997.

S&P said results from a proprietary default forecast model indicate that U.S. speculative-grade default rates will continue to edge up slowly in the next few quarters, reaching 2.8% by the fourth quarter of 2006.

The U.S. speculative-grade default rate is expected to reach 4.5% by the end of 2007, still below its 4.7% long-term average.

As of April 10, S&P said a total of 16 weakest links remained vulnerable to default on rated debt worth $5.4 billion, one fewer than a month earlier and four fewer than the average of 20 entities recorded over full-year 2005.

U.S.-based issuers, including tax havens, constituted 13 of 16 issuers.

"As defaults inch higher, spreads should begin to increase as well," S&P's Diane Vazza said in a news release.

According to the release, 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 around 425 basis points by the end of the first quarter next year, compared with 335 bps seen at the end of this quarter, bringing spreads more in line with their median range since 2003.

S&P said bond spreads on speculative-grade issues have already improved from their record lows, even though spreads remain narrower than their April-May highs.

According to S&P, in the United States and Europe, a rising proportion of lower-grade issuance - B- or lower as a percent of total speculative-grade issuance - beginning in 2003 serves as an early warning of renewed default pressure within two years.

Lower grade issuance falls

In the United States, the proportion of lower-grade issuance dipped to 21% in the first quarter - its lowest level in 13 quarters and a stark contrast from 45% in the fourth quarter. The ratio had averaged 42% for full-year 2005, 43% in 2004 and 31% in 2003.

Meanwhile, in Europe, for the three months ended March 31, the proportion of lower-grade issuance eased to 41%, from 43% in the fourth quarter of 2005. In Europe, the ratio was 39% for full-year 2005, 45% in 2004 and 22% in 2003.

The ratio has remained at more than 30% for 10 consecutive quarters in Europe and had remained higher than 30% for 10 quarters in the United States until the decline in the most recent quarter.

S&P said 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, a greater net percentage, 11%, 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 that reported easing standards increased to 7% in January from 5% in October.

Furthermore, 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 - declined in 2003 and appears to have bottomed out in 2005, as the distress ratio was 4.75% at the end of March, which is less than the 6.2% average for full-year 2005.

Telecom, auto, retail, consumer products weak

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

Default rates in the U.S. leveraged loan market have been edging higher, with the default rate at 2.08% at the end of March, compared with 1.34% six months earlier and 1.12% at year-end 2004.

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 default rates sliding back to 1.32% one year ahead, according to a proprietary model.

The U.S. recorded a speculative-grade default rate of 1.91%, which is also lower than its long-term 1981-2005 average of 4.70%.

European speculative-grade default rates remained at zero at the end of March, as there have been no European defaults in the trailing 12 months. In the emerging markets, a 0.21% default rate was recorded at the end of March versus 0.67% six months earlier.

The only default in the emerging markets that has been observed in the trailing 12 months was Administracion Nacional De Combustibles Alcohol Y Portland of Uruguay.

Transportation tops U.S. defaults

In the United States, S&P said the highest default rates by industry in the trailing 12 months were recorded in the transportation sector.

In year-to-date 2006, six defaults were recorded, affecting rated debt worth $4.3 billion, compared with a total of 37 defaults in 2005 affecting debt outstanding worth $42.5 billion.

The two defaults recorded in March were Dana Corp. and its subsidiary, Dana Credit Corp.

The current list of 16 weakest links is one fewer than the number reported one month earlier and four fewer than the average of 20 entities recorded in full-year 2005.

With three issuers each, S&P said the forest products and building materials and the media and entertainment sectors showed the highest vulnerability to default among the weakest links, each constituting 18.8% of the issuers on the most recent weakest links list. Next in line were the automotive; chemicals, packaging and environmental services; and consumer products sectors, with two issuers each.

Outside of the United States, one issuer from the United Kingdom, one from Belize and one from Canada were among the weakest links.

In 2006, chemicals, packaging, and environmental services has been the leading issuer, with $235 million in issuance occurring in the paper and plastic manufacturing segment year to date.

In addition, S&P said other industrial subsectors, including capital goods and high technology, each issued more than $200 million in the first quarter of 2006.

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