Default in iTraxx Crossover unlikely in 2009, says Barcap

In its outlook on 2009 European defaults, published today, Barcap says it is unlikely that there will be a default among itraxx Crossover constituents. As caveat, Barcaps examines the possibility of six extremely unlikely ‘surprises’.

While the analysts allow that fundamentals will come under pressure, based on a combination of heavy maturities in relation to the size of the balance sheet, high leverage and lower coverage, they do not see any names as being close to default. In a pessimistic scenario, if one or two names default, Barcap thinks there will be a limited issuer default rate of 2-4% on the Crossover.

However, unlike this year’s low default rates in European high yield, Barcap anticipates its increase based on surging cost bases, slowing macro growth, tightening lending standards, and low maturity volumes.

Names on the iTraxx Crossover index are rated above B1 or equivalent, and are less prone to default insofar as the economic environment does not deteriorate further. Potential “weak links” include Ineos and LyondellBasell. In contrast, members of the LevX index retain much higher default risk due to poorer fundamentals, although private documentation inevitably makes forecasting difficult.

Similarly, defaults due to missed coupon payments and covenant breaches, as well as deteriorating earnings are most likely amongst issuers rated B3 (or equivalent) and below. Barcap has deduced from such observations a European high yield default forecast ranging between 3.3 to 5%. Should the economic cycle worsen, those names rated B1 or B2 could face difficulties. A high probability of survival of low-rated issuers, however, only begs the question of how they will improve their fundamentals post-2009.