S&P forecast: U.S. junk default rate to hit 3.7% by September 2013

By Caroline Salls

Pittsburgh, Nov. 15 - Standard & Poor's expects the U.S. corporate trailing 12-month speculative-grade default rate to increase to 3.7% by September 2013 from 3% as of September 2012, according to a report titled "U.S. Corporate Default Rate Forecasted To Rise To 3.7% By Third-Quarter 2013."

S&P said its baseline projection is lower than the long-term 1981-2011 average of 4.5%.

A total of 58 issuers would need to default in the 12 months ending September 2013 to reach this projection. By contrast, S&P said 46 speculative-grade entities defaulted in the 12 months ended September 2012.

The ratings agency said its baseline forecast is partly based on the assumptions that U.S. economic growth will continue to be slow and the unemployment rate will remain elevated.

Growth outlook

According to the report, the Bureau of Economic Analysis' advanced estimate for real GDP growth in third quarter of this year was 2.0%, following a 1.3% growth in the second quarter.

S&P said it expects real GDP growth of 2.1% for full-year 2012 and 2.3% in 2013.

The agency said Bureau of Labor statistics show 171,000 new jobs were created in October, bringing the 2012 annual total to more than 1.5 million jobs created.

While any new job created is encouraging, S&P said the economy still has some ground to make up for the 8.7 million jobs lost in 2008 and 2009.

In addition, the unemployment rate remains elevated, at 7.9% as of October. S&P said it expects the rate to decline modestly to about 7.5% by the fourth quarter of 2013.

S&P said capital inflows into the credit markets have been healthy in 2012, which helped to keep the count of default occurrences relatively low. The Federal Reserve has also kept interest rates low for an extended period of time, and it has pledged to continue its quantitative easing until the labor market improves, the report said.

Fiscal cliff

Although recently reelected President Obama and the congressional leaders have expressed some willingness to reach a compromise to prevent the United States from "falling off the cliff," S&P said the uncertainty that surrounds the possibility of U.S. lawmakers not reaching an agreement continues to threaten the U.S. recovery and makes investors nervous.

The ratings agency said various market observers estimate that the impact of going over the fiscal cliff could result in a fiscal contraction of 3% to 5% of GDP.

"In essence, it could send the U.S. economy back into a recession," S&P said.

S&P said an escalation in Europe's sovereign crisis could also easily temper or reverser investor appetite for corporate bonds.

Optimistic, pessimistic scenarios

S&P said its optimistic default rate forecast assumes a much improved U.S. economy, buoyed by U.S. lawmakers agreeing on a sound deficit-reduction plan, a faster-than-expected improvement in the labor market, which would spur consumer spending, and stronger growth abroad.

Under the optimistic scenario, S&P said it would expect the default rate to decline to

2.5% by September 2013, or 39 defaults during the next 12 months.

On the other hand, the agency said its pessimistic scenario assumes that the U.S. reverts back into recession in the next few quarters, succumbing to the threat of the fiscal cliff as U.S. lawmakers face political gridlock. Also under the pessimistic scenario, the sovereign crisis in Europe proves to be more protracted and deeper, resulting in loss of investor, business and consumer confidence, which in turn restrains business and consumer spending.

Revenue declines would squeeze corporate profits in this case, and growth of emerging Asian economies could slow further, hurting U.S. exports in the process.

Under this pessimistic scenario, S&P said it expects the default rate to rise to 5.7%, or 90 defaults during the next 12 months.

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