Corporate bond defaults to rise -- Economic slowing, credit crunch take two companies bankrupt this week

"You'll see a lot more credit defaults over the next 24 months as economic conditions soften," said Sean Egan, managing director at ratings agency Egan-Jones Ratings.

In past years, aggressive private equity buyers and fairly lenient lending standards helped struggling corporations stay afloat, he said.

That's all changed. The U.S. economy looks increasingly likely to fall into a recession, Europe is cooling and both lenders and private equity buyers remain on the sidelines. On Wednesday, Cerberus Capital Management Chairman John Snow said banks needed to "purge" about $200 billion of loans they can't sell to investors before the hot pace of leveraged buyouts resumes, reported Bloomberg.

For individual companies, reduced consumer spending and manufacturing activity have been crimping sales, while a continued credit crunch makes it harder for companies to refinance high-priced loans, say analysts.

Standard & Poor's on Tuesday forecast the default rate on speculative-grade bonds, commonly known as junk bonds, will rise to 3.4% this year - a big move up from last year's rate of 0.97%, which was a 25-year low. Last year only 22 defaults were recorded globally, the lowest default count in 11 years, said the rating agency.

Changes in the credit markets, an increase in refunding needs and a higher risk of recession account for the worsened outlook for bond defaults, says Diane Vazza, head of fixed income research at Standard & Poor's. In fact, she views the Federal Reserve's surprise 75 basis-point cut, announced Tuesday, "as indicative of the accelerating risk of recession."

An increase in bond defaults is likely to keep up pressure on the equity markets, which have been shocked by repeated bad news about subprime mortage defaults, mortgage-backed securities losses, and more lately, mounting risks from bond insurers and credit default swaps.

When a big company defaults on its debt, that action generally triggers an event in credit default swaps - the contracts that give the buyer of the swap a form of insurance against the possibility a specific issuer will renege on its debt. But following the near failure of bond insurer ACA Capital Inc.(ACAH:

0.72, -0.08, -10.0%) , market participants have increasingly worried that counterparties in credit default swap contracts won't pay up. See related story.

"There is great uncertainty about the impact of those [bond] defaults in a world of structured finance and credit-default swaps," said Joseph Mason, a professor of finance at Drexel University. "Where credit default swaps were issued for speculation, losses in the sector will magnify - rather than offset - losses from any given default," he said in emailed comments.

Montreal-based printer Quebecor World Inc. (IQW:

, , ) (CA:IQW: news, chart,profile) and Eagan, Minn. restaurant-chain Buffet Holdings are the latest examples of what happens when a weaker economy combines with a tough market for getting new loans.

On Monday, Quebecor said it was filing for bankruptcy protection in Canada and the United States after failing to secure a $388 million (C$400 million) bail-out package and warning it was running out of cash. The 28,000-employee company, which produces printed materials like direct mail and magazines, has been struggling with slowing demand, higher energy costs and a strong Canadian dollar. Last month, a planned sale of some European operations fell through.

"This is an industry in secular decline, hurt by the online and electronic move in advertising," said Tom Ferguson, an analyst with high-yield research firm KDP Investment Advisors. "Margins are under pressure from all corners," he said.

Still, he said he was a "bit surprised" that Quebecor couldn't come up with new funding, particularly since just two years ago, bond investors flocked to buy new Quebecor debt.

Part-owner Quebecor Inc. (CA:QBRA: news, chart, profile) had tried to arrange rescue financing with a private equity firm but said some of Quebecor World's lenders had balked at the financing arrangement.

Quebecor's failure to come up with financing to forestall bankruptcy, "speaks volumes about the current status of the credit market," Ferguson said.

Tighter credit market conditions are curtailing the ability for companies to get new financing across a range of industries. Moody's Investors Service said Wednesday that the number of speculative-grade companies with weak liquidity ratings rose by 77% in the second half of 2007 compared to the first half.

This jump signals more companies are vulnerable to default, noted the ratings agency. Quebecor World, for instance, received a weak rating last June.

Meanwhile, a slowdown in consumer purchases is sapping profits at some retail companies. Buffet Holdings, Inc., the privately-held operator of restaurant chains including HomeTown Buffet and Tahoe Joe's Famous Steakhouse, filed for Chapter 11 in Delaware Tuesday.

Belt-tightening by consumers, who have seen gasoline prices top $3 a gallon and home prices fall, has translated to lower sales for restaurant chains. Last year, Specialty Restaurant Group and The Roadhouse Grill filed for U.S. bankruptcy.

Top among the reasons its operations went south, said Buffet Holdings Tuesday, was a "significant decline in discretionary spending among its core consumers."

An increase in corporate defaults is also likely to have a ripple effect on the large but obscure market for credit default swaps.

The Quebecor default, for instance, has triggered a credit event in credit default swaps, according to analysts at Bank of America Corp. This means that the holders of credit default swaps linked to Quebecor defaulting on its debt stand to get paid for those swaps, while the sellers of credit default swaps must pay up.