Capital Markets

Rating Agency Warns of Future Defaults

The global default rate is low today, says Standard and Poor's, but default pressure may rise not far in the future.
Stephen TaubMarch 2, 2004

Credit rating agency Standard and Poor’s announced that the global default rate fell to 4.21 percent at the end of February, from a revised rate of 4.64 percent in January.

The current rate is well below the average of 5.3 percent dating back to 1981, and S&P predicts that the default rate will continue to drift lower in 2004. The reasons for the continued improvement include expectations for greater economic strength, continued favorable financing conditions, and improving corporate profitability.

Despite the optimism, however, S&P warned that it is concerned about an increase in defaults in the next two to three years due to a rising proportion of lower-grade issuance in the United States, and to a lesser extent in Europe.

Lower-grade issuance — rated B- or lower — accounted for 45 percent of new U.S. issues in February and 47 percent in January, compared with just 31 percent for 2003.

Indeed, due to favorable demand and supply conditions, the number of U.S. issuers approaching the high-yield bond market for the first time — both for ratings and issuance — doubled in 2003 compared with the two previous years. Even so, the total 77 first-timers in 2003 was well below the annual peak of 256 seen in 1997.

Many of the first-time U.S. issuers in 2003 came from the consumer products, health care, and media and entertainment sectors, reported the rating agency.

S&P pointed out that average credit rating among these first-time issuers falls around a B+, which generally corresponds with a B- rating at the issue level.

“This rising influx of lower-rated issuers into the U.S. speculative-grade market spells caution for credit quality and defaults down the road,” noted the report. “When the share of lower-grade issuance (particularly at the ‘B-‘ level or lower) exceeds 30 percent for a sustained period of time, it generally serves as a reliable indicator of imminent default pressure two to three years ahead.”