S&P Sees Far Fewer Defaults Ahead

Borrower-friendly developments in the credit markets have inspired one of the ratings agencies to halve its speculative-grade default forecast for the year to come. That is good news for buyout firms, whose portfolio companies have represented about a third of U.S. defaulters so far in 2009.

A recent swell in new issuance, combined with lender forbearance to troubled issuers, has led Standard & Poor’s to slash its September 2010 high-yield default forecast for U.S. issuers to 6.9 percent from 13.9 percent. As of September 2009, the U.S. 12-month-trailing corporate speculative-grade default rate stood at 10.8 percent.

S&P also provides a best-case and worst-case projection. Its new optimistic projection for the U.S. speculative-grade default rate is 5.5 percent (versus the previous 11.4 percent), while its pessimistic outlook is 9.9 percent (down from the previous 18 percent). “Financial conditions are clearly on the mend, in our view,” S&P said in its report dated Oct. 21.

The pace of sponsor-backed defaults has already shown signs of deceleration. With only three portfolio company defaults, September was the slowest month of the year, and at press time on Oct. 23, October was shaping up to be even better. Recent defaulters include Veronis Suhler Stevenson’s publisher Advanstar Inc. (Oct. 02) and Clayton Dubilier & Rice’s building products producer NCI Building Systems Inc. (Oct. 20). [Editor’s note: this paragraph has been editied since its Nov. 2 publication date to reflect a correction. See below for correction.]

S&P points to several encouraging signs in its report, including a significant increase in new issuance among speculative-grade-rated entities since late spring. Of the $90.4 billion in new speculative-grade deals that have come to market since January, almost 80 percent was recorded in May or later, according to S&P.

In September, U.S. companies issued $16.6 billion in high-yield debt, far more than the $1.0 billion recorded in September 2008 and the $3.9 billion recorded in September 2007, the ratings agency said. Of September 2009’s total new issuance, almost $6.0 billion was rated ‘B-’ or lower, the highest volume since November 2007. “This suggests that investors’ appetite for risk is back and that they are receptive even to the lowest-rated issuers that are coming to market,” the report said.

S&P also sees a more benign mood developing among lenders. “As forbearance increases, some leveraged corporations will be able to delay default and take advantage of the reopening of refinancing channels,” the ratings agency said.

Moreover, lenders have been willing to work with distressed issuers before a forbearance agreement would even be necessary by using strategies that include bond-for-loan takeouts, loan maturity extensions, covenant amendments or resets, and equity cures. According to Standard & Poor’s Leveraged Commentary & Data, 19 percent of companies listed on the S&P/LSTA leveraged loan index have reset covenant levels in the previous 12 months.

Correction: An earlier version of this story incorrectly listed a third sponsor-backed default that took place in October. In addition to the two sponsor-backed defaults listed above, Buyouts included the Oct. 21 default of financial services provider NIS Group Co. Ltd., noting erroneously that the company was backed at the time by TPG. However, TPG had exited its investment in NIS Group in March 2009.