The rising and falling default rate

August 20, 2009

Stock photo of Javier Ramirez is seen through the crystal ball while practicing before a show in the national jugglers encounter in Concepcion, 500 km from Santiago. Picture taken March 12, 2004.  	 REUTERS/STR NewRating agencies Moody’s and S&P regularly publish figures on how many companies have defaulted on their debt, and the numbers are rising fast.

S&P’s latest report, which came out on Thursday, shows the global speculative-grade bond default rate increased to 8.58% in July, up slightly on June, and a massive hike on the record low of 0.79% hit in November 2007.

It is less clear what will happen next. Earlier this year the agencies predicted defaults amongst speculative grade borrowers could reach 20 percent — a huge increase — but now agencies have rowed back and are painting a slightly less bleak picture.

S&P’s new report says the number of “weakest links” — companies with low (B- or worse) ratings on review for a downgrade or with a negative outlook — has declined. This, the agency says, is because the increased number of defaults has knocked out many of these weak credits.

A sliver of silver lining around this grey cloud is that the rate of companies falling into weakest-link territory is lower than the number of companies defaulting, which may suggest the default rate may ease sooner rather than later.

The reopening of the credit markets, and banks’ determination not to write off debts, seems to have slowed the pace of defaults. However, talk of double-dip recessions may mean rating agencies’ earlier, bleaker predictions may end up being proved correct, just over a longer time frame.

Whichever way it finishes, little of this will help rating agencies’ reputation for making accurate predictions.

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