Liquidity Stress Index Points to Declining Default Rate, Moody’s Says

The Liquidity Stress Index (LSI) from Moody’s Investors Service will finish the year in a drop, signaling a moderation in defaults among speculative-grade companies for the coming year, the ratings agency said in its recent SGL Monitor.

“The past year has been choppy for speculative-grade liquidity, with weakness in the commodity sector pushing the LSI to a six-year high in the first quarter and contributing to a jump in defaults,” said Moody’s Senior Vice President John Puchalla. “But since then, the index has trended more favorably, falling below its historical average of 6.8% in October, a milestone related to the gradual letup of challenges in the oil and gas sector and continued good market access for most speculative-grade borrowers.”

The LSI falls when corporate liquidity appears to improve and rises when it appears to weaken. It reached 6% in mid-December. Puchalla said that the sharp drop in the oil and gas sector LSI to 17.1% from a high of 31.6% in March indicates the easing of liquidity and default pressures for the sector in 2017. Balance sheets and investment capacity have improved through asset sales and new financing.

Challenges exist, even in light of expected U.S. economic growth in 2017. Vulnerabilities may lie in the dependence on the market for liquidity and the weak rating distribution of speculative-grade borrowers, but such challenges appear manageable, according to the ratings agency, who expects the U.S. speculative-grade default rate, currently at 5.6%, to reach about 4% by the end of 2017.

The agency’s Covenant Stress Index reached 3.9% in November, down from 4.3% in October, an indication that speculative-grade companies remain at low risk of violating their debt covenants, Moody’s said.

– Adam Fusco, editorial associate

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