S&P Expects US Junk Bond Default Rate to Triple
Standard & Poor’s expects the rate of default in the U.S. speculative-grade segment to increase materially in the next 12 months, reaching 7.6% by September 2009, the highest level in nearly six years. Under a “pessimistic scenario,” the rate could go as high as 9.6%.
In a report published today, S&P said the spread of tumult across a variety of markets including, but not limited to, interbank lending, bonds, and equities, has been countered with aggressive government intervention. “But, we do not expect the turmoil to pass without incident for a broader swathe of corporations and the economy in general.”
The number of corporate casualties is increasing in the U.S. in line with expectations, but it still remains relatively limited considering the financial upheaval in the third quarter. A total of 24 defaults were recorded
during the most recent quarter in the U.S., compared with 20 in the second and 16 in the first, according to the report, “Financial Tumult Pellets Corporates, Exacerbates Default Outlook Threefold.”
More trouble lies ahead, and we expect defaults to continue to gain momentum in the next 12 months. We have substantially raised our baseline default expectations for the U.S. speculative-grade segment, in line with more pronounced weakness in economic expectations.
“In our baseline scenario (to which we’ve assigned a 60% probability), we expect the U.S. speculative-grade default rate to escalate to a mean forecast of 7.6% in the next 12 months (through September 2009), with a
one-standard-deviation range of 6.5%-8.7%. This predicted range is multiples higher than the 2.68% trailing-12-month default rate observed in September 2008 and the 25-year low of 0.97% in December 2007.”
The pessimistic scenario yields a mean default rate of 9.6%, more than double the long-term average of 4.4% but still below the peaks of 10.8% in the 2001-2002 recession and 12.5% in the 1991-1992 recession. The optimistic scenario yields an average default rate of 6.1%. In the next 12 months.
S&P said factors contributing to incrementally higher downside risks for U.S. defaults include:
- A deep freeze in the lending markets as a result of unprecedented volatility and seismic changes in the financial markets beginning in September. The funding difficulties reported even by blue-chip corporations underscore the extreme conditions facing corporate borrowers and connote trouble for firms most in need of capital.
- Deepening recessionary conditions in the U.S. For example, payrolls have now dropped for nine consecutive months, causing the unemployment rate to increase to 6.1% from 4.4%.
- A larger proportion of speculative-grade issuers than at any other point in history.
- The highest volume of low-rated issuance since 2003.
- A greater impact of seasoning in the ‘B-’ or lower rating categories, referring to the phenomenon that companies seldom default during the first few years after accessing the public debt markets, regardless of the initial rating assigned.
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