(Corporate) Defaults seen as unlikely to rise

Defaults seen as unlikely to rise

http://www.ft.com/cms/s/fc64dda6-cc16-11db-a661-000b5df10621.html

By Chris Hughes and Paul J Davies

Published: March 6 2007 21:36 | Last updated: March 6 2007 21:36

Corporate default rates were unlikely to rise until the middle of 2008 as the continuing abundant supply of credit has enabled companies to refinance their way out of difficulty, Ernst & Young said on Tuesday.

The upbeat predictions are striking given the turmoil witnessed in credit derivatives markets over the past week, which has seen a higher re-pricing of risk, particularly in high yield debt.

Keith McGregor, E&Y partner, said lenders remained under pressure to put money to work, so borrowers could negotiate lenient covenants and threaten to refinance if they breached those covenants.

Many companies that participated in the refinancing boom of the past three years, including private equity deals, would not be obliged to make repayments on their debt until next year, he added.

“Liquidity has to go away before we see an uptick in default rates,” said Mr McGregor. “There’s no structural reason why the level of defaults should tick up . . . Given the fact that the vast majority of leveraged buy-outs are less than two years old, it doesn’t look like there will be an uptick before the middle of 2008.”

While derivatives on bond issues have seen wild price swings in the past week, cash bond markets have been less affected and the loan markets that provide the bulk of leveraged buy-out financing have escaped unscathed.

E&Y said the annual default rate on mezzanine debt would have exceeded 2.5 per cent in the fourth quarter of 2006 – against an actual figure of just less than 2 per cent – if companies had not benefited from easy refinancing or relaxed banking covenants.

Alan Bloom, head of E&Y’s UK corporate restructuring practice, said there were already a number of walking wounded among leveraged buy-outs.

“We are seeing companies being propped up that we would not imagine being propped up. People are rushing to rescue companies,” he said.

Only a handful of leveraged businesses have run into trouble in recent times, including companies such as Focus, the UK DIY chain, Schefenacker, the German autoparts maker, and Damovo, a telecommunications services company.

One trigger for a withdrawal of liquidity might be if investors switched from credit to equities, Mr McGregor said.