The figures are alarming. A worldwide survey by Standard & Poor's shows that 55 rated companies failed in the first half of 1999, defaulting on total debts of $20.5 billion. That easily exceeds the 37 failures and $8.3 billion in defaulted debts in the second half of 1998, when the rising default trend began. What's worrying is that, while common sense and historical data teach that the level and volatility of default rates rises in a recession, the US is in anything but that.
Most of the defaulters - 39 out of 55 - are US-based. The phenomenon spans all sectors, from shipping to coal mining, restaurants to medical supplies. One common thread is that many of the companies are young, with 46 having been rated for five years or less.
Nicholas Riccio, managing director of corporate ratings at S&P, argues: "There is no macroeconomic explanation behind this upsurge. They are just companies run badly in a US economy that is performing very well. They are basically individual business failures: companies that just could not cope with competitors because of their internal weaknesses."
According to Riccio, the trend is the natural consequence of the boom in the US high-yield bond market since it recovered from the crisis of 1990-91. "With a lot of investors looking for higher returns, a growing number of companies have accessed the capital markets over the last few years looking for an easier source of money. That has meant that the creditworthiness based on S&P ratings has lowered, reflecting the greater risk the market is taking."
During the 1980s, typical corporate paper was rated B+. The number of B and B- ratings has increased notably during the 1990s, with a fair amount of companies rated CCC. Of the 55 defaults in the first half of 1999 and the 37 failures in the previous half, only four and five respectively were ever rated investment grade, and all of those were triple-Bs. Only 15% of the companies were ever rated above BB-.
Even if bad management is the main cause of defaults, it is no coincidence that the upward trend began at the time of the 1998 Russian debt crisis. Seven Russian banks failed last August, and all but four of the 21 non-American corporate defaulters in the past year were based in emerging market countries. Riccio says: "The troubles in emerging markets have had an impact. And it affected not only the domestic companies but the US ones as well."
With investors dodging risk everywhere, Riccio explains, yield spreads in the US between B-rated bonds and treasuries more than doubled between May and October 1998, with the result that some companies could not roll over long-term debt. Corporates exporting to emerging markets, as well as oil and gas companies, were particularly affected.
At Moody's, a new model for predicting default rates was introduced in July. The model is supposed to generate 12-month forecasts with an accuracy of about 85% for all corporates and about 80% for speculative credits. By June 2000, the overall default rate is expected to rise to 2.2%, while a level of 5.53% is forecast for sub-investment grade. The macroeconomic background of the recent rise in interest rates and the steepening of the yield curve adds to the chances of defaults.
Continued corporate defaults could have an adverse effect on the financial performance of banks. US banks' performance has soared during the 1990s. The banking sector's problem loans, at 8% in the early 1990s, are now well below 1%. But according to S&P, the top 15 banks' bad loans have risen from 0.81% to 0.91% in the past year.
S&P credit analyst Tanya Arzachs says in a recent study: "It would take a confirmed pessimist to find anything wrong with the present crop of 1999 second-quarter earnings releases for US banks, but there is a small cloud on the horizon." Luciano Mondellini
Speculative-grade default rate and forecast
Source:Source: Moody's Investors Service
CORRECTION
Awards for excellence
In our July edition, we omitted the Moldova section from our awards for excellence. Apologies and congratulations to AgroInd Bank, our best bank in Moldova.