By Karen Brettell
NEW YORK, Aug 19 Banks are significantly
tightening their purse strings when it comes to lending to U.S.
companies and, as credit dries up, defaults are also likely to
accelerate at a faster rate than now reflected in the debt
Bonds of the riskiest companies, which are at the lower end
of the rating spectrum, are also trading at tighter levels than
in previous downturns and are most likely to underperform as
The July survey of senior loan officers, released by the
Federal Reserve last week, found that 60 percent of domestic
banks reported tightening credit standards on commercial and
Eighty percent of banks also said they had increased the
spreads of loan rates over their cost of funds on loans to
large- and middle-market firms. For details, see
"The pace of bank credit tightening has become draconian in
scope and now stands at the recessionary levels last seen in
1991 and 2002," credit analyst Christopher Garman said in a
report. "This promises a rapid increase in default rates over
the next few quarters."
Tighter lending standards have historically had a strong
relationship with default rates, he said.
"The relationship is rock-solid in statistical terms,"
Garman said. "Tighter policy leads Last Twelve Months (LTM)
default rates by nine months, with 84 percent reliability. The
relationship points us toward 11.4 percent default rates by
This is larger than rating agency or market estimates.
Standard & Poor's said on Tuesday that market expectations
of defaults have risen in the past three months to around 9
percent over the coming year, from 7 percent previously.
"Our forecast is for the 12-month trailing
speculative-grade default rate in the U.S. to increase to 4.9
percent 12 months forward," S&P analyst Diane Vazza said in a
report. "Our pessimistic scenario, based on a
larger-than-expected deterioration in economic fundamentals,
has the default rate rising to 8.5 percent within 12 months."
Moody's Investors Service said last week that the default
rate for U.S. speculative-grade issuers could increase to 5.7
percent by the end of the year and to 7.2 percent a year from
In the United States, the default rate rose to 3 percent in
July from June's revised level of 2.5 percent and 1.5 percent a
year ago. The last time the default count hit double-digit
levels was in July 2003 when 11 companies defaulted, according
to Moody's data.
And while reduced demand for high-yield debt has led
spreads weaker in previous months, the riskiest "CCC"-rated
credits may still not be pricing in their default risks, said
Garman, publisher of Leverage World.
Average "CCC"-rated company spreads are trading at 1,280
basis points over Treasuries, Garman said.
But, "at this level of commercial bank unwillingness to
lend, CCCs should show spreads of 1950 basis points, or a rise
of near-7 percent in yield," he said. "This level would be
comparable to CCC spreads in 1990 or 2001-2002."
Bonds of companies rated in the "BB" and "B" junk rating
buckets are trading at levels that are in line with tighter
lending standards, he added.
(Editing by Jonathan Oatis)