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Credit Quality Rapidly Improving

credit quality protectionHere are more encouraging signs that the economic recovery continues to gain strength.

Credit quality continues to improve and some indicators stand at two-year highs.

According to Standard & Poor’s, the US speculative-grade default rate fell to 3.35 percent in mid-December, down from a peak of 11.4 percent hit in November 2009. In the US, 53 issuers defaulted through November, compared with 185 at the same time in 2009.

There are other good signs. The speculative-grade corporate bond spread-most recently around 539 basis points. This is just a tad above its 2010 low point of 537 basis points seen on April 26. However, such result is down from 568 basis points a month earlier.

In addition, the spread on investment-grade bonds fell to 181 basis points from 195 points a month earlier.

The Distress Ratio

Meanwhile, the distress ratio is down to 6.5 percent from 8.4 percent in November. What’s more, the distress ratio is lower than its long-term average of 15.5 percent. In fact, this is at its lowest point in three years.

“As a potential precursor to default activity, this portends an optimistic future for corporate borrowers in the near term,” S&P states in a new report. It adds that the steady decline in the distress ratio has pushed the 12-month. The decline is moving average down to 10.3 percent from 16.4 percent six months ago. This indicates an extended period of more-favorable lending conditions.

The distress ratio is defined as the number of distressed securities divided by the total number of speculative-grade-rated issues. Distressed credits are speculative-grade-rated issues that have option-adjusted spreads of more than 1,000 basis points relative to Treasuries.

“A rising distress ratio reflects an increased need for capital, and it typically proves to be a precursor to more defaults if accompanied by a market disruption,” S&P explains in its report.

Among distressed bonds, the total number of companies with issues trading with spreads of 1,000 basis points and higher is currently 69. This is down from 85 in November. In addition, the number of affected issues decreased to 96 as of mid-December from 121 in November.

There is also good news in the loan market. The S&P/LSTA Leveraged Loan Index distress ratio dropped to 7.7 percent at the end of November from 7.9 percent in the previous month.

“Although the unemployment rate remains stubbornly high, most other variables that typically influence the default rate are now at more benign and neutral rates,” S&P stresses in a new report. “Corporate spreads are much lower than their record highs, reached in December 2008 at the height of the most recent recession, and they have leveled off at a magnitude consistent with a nascent recovery.”


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