S&P report says U.S. corporate defaults loom at $35 billion

By Susanna Moon

Chicago, Sept. 19 - Over the next 15 months, U.S. corporate defaults could top $35 billion based on the weakest 75 U.S. corporate credits, according to a report by Standard & Poor's.

The favorable borrowing terms of the past few years spurred a surge in the number of highly leveraged B-rated new debt issuers, the agency said, and the growth of such low-quality credit borrowers could spark a rise in defaults over the next year.

U.S. corporate defaults so far this year have totaled $4.5 billion for 15 defaults, according to the agency. And the projected defaults could be a conservative estimate, S&P noted, if credit and economic conditions slip to 2001 to 2002 levels when markets saw $250 billion of corporate debt defaults.

Companies rated at least BB are likely to weather at least several months of market turbulence, the agency said, while companies rated B and lower are most vulnerable, considering the current market volatility.

Wealth effect hangover

According to the agency, the recent expansion was fueled by consumer spending from the so-called wealth effect stemming from the real estate bubble. As a result, the country could see lagging effects from mortgage defaults, home price devaluation and high commodity prices.

As with its economic outlook, the agency said it sees few near-term signs that a surge in benchmark interest rates will weigh on companies' ability to service their variable-rate debt. But any rise in borrowing costs may cause a credit downturn as the credit markets re-price risk if consumers become wary of spending, S&P said.

Speculative-grade borrowers face the greatest challenges, and defaults will rise substantially from their recent record-low levels, the agency predicted.

The credit crunch could linger into 2008, S&P said, and will resolve itself as the financial markets re-price existing securities and begin to absorb the billions of dollars in committed underwritten debt impairing banks.

The next eight to 12 months

In the period before the current market disruption, S&P said it identified nearly 100 credits out of nearly 2,000 U.S. industrial and utility companies that required "special attention" for their liquidity situation. Of these, two-thirds were rated in the B category. The agency excluded homebuilders from the review, which will be examined separately.

S&P's review focused on a company's ability to finance itself over the next eight to 12 months, assuming it's hard for them to raise funds and sell assets. The analysis looked at debt maturity schedules and companies' ability to borrow under credit lines or tap other backup sources, including cash on hand.

As expected, highly rated companies fared best, and investment-grade bond issuance was robust over the past six weeks, S&P said. But liquidity could be an issue in the current environment, the agency noted, with investors more risk-sensitive than they've been in a while.

For BB-rated credits, many of the companies have negative outlooks, which could reflect their own specific liquidity risks, S&P said. And the current market environment does not warrant any rating revisions on individual companies. One reason for this is the recent market liquidity that allowed many companies to refinance bonds and extend their maturities, the agency said.

Companies with low ratings are most vulnerable, with the group of credits rated B and below constituting more than 40% of nonfinancial corporate ratings in the United States, according to S&P, up from 35% a decade ago. The typical B category credit had an average debt-to-EBITDA ratio of 6 times in 2006. And as new issuer ratings migrate down the B category, it's more common to see leverage of much higher than 6 times, the agency added.

The B-rated companies rely on financial markets for operating cash, but S&P said the ample liquidity of recent years is unlikely again for high-yield borrowers. Over the coming year, the agency said it sees some risk of a protracted economic slump, a sustained rise in borrowing costs and problems executing planned asset sales.

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