S&P Sees Credit Quality Slide in 2007

Corporate credit quality will begin a slow and gradual slide in 2007, especially in the lower-quality, high-yield sector, according to Standard & Poor's.

"We believe 2007 will be a transition year to more normal conditions," the credit-rating firm assures in its annual credit forecast.

S&P expects credit risks to build up incrementally, particularly toward the end of next year, as pressure grows on yields, spreads, and returns. "No major dislocation in the credit cycle is anticipated during the course of 2007, however, and chances appear slight that isolated instances of distress will derail the market," it adds.

Downgrades and defaults will rise as the year progresses, according to the firm, which notes, though, that default rates will fall well short of historical averages. At the same time, companies with lower ratings will start to increase, as will bond yields, the firm says.

In terms of metrics, the outlook is a blurry one. On one hand, in November the 12-month trailing speculative-grade default rate moved to a record low of 1.26 percent from an already low 1.27 percent in October. And the 197 upgrades and 319 downgrades seen through November are beating the 188 upgrade and 324 downgrade relationship of 2005.

S&P warns, however, that, the improvement is centered in the high-grade sector. "Other leading credit quality measures show more visible stress vis-à-vis last year," the agency notes. For example, 25 percent of issuers have a negative outlook or negative ratings on CreditWatch, as do 30 percent of "B" rated issuers and 77 percent of the 68 firms rated "CCC" or lower. As the profit cycle turns, S&P expects the speculative-grade default rate to reach 3 percent by late 2007.