Here is yet another sign the economy is in better shape than the skeptics think it is...maybe.
Standard & Poor's said it expects the US corporate speculative-grade default rate to plummet to 2.8 percent for the 12-months ending June 2011. This is less than the current rate of 5.9 percent.
Why the optimism? After all, while the economy shows signs of strengthening, there are still a large number of ominous signs and experts are somewhat divided over whether we will be entering a second recession or experience deflation, which would be devastating to indebted companies.
S&P, however, is hopeful, pointing out that the pace of downgrades has decelerated, negative bias has declined, and bank lending conditions have improved from the end of the first quarter.
"We believe the US economy is continuing on a path of recovery, even though it appeared to be moving a little slower in the second quarter as the government wound down some of its stimulus spending," the ratings agency said in a recent report.
Another reason S&P is confident the default rate will drop sharply: A modest amount of debt is poised to mature over the next four quarters.
However, don't think the worst is behind us when it comes to defaults. S&P believes that after this upcoming favorable 12-month period, default risk could increase because of the significant overhang of surviving leveraged corporate issuers and the sizable amount of debt that is coming due.
Granted, more than 50 percent of the leveraged issuers originated from 2003 to 2007 have survived. However, S&P warns that unless top-line growth improves significantly or leverage declines, these entities will likely continue to face high default risk. "We expect the survival rate will eventually decline," it adds in the report.
What's more, it expects speculative-grade entities' refunding needs will rise significantly in the coming years and thinks the market may have trouble absorbing them.
For example, $120 billion of junk debt is maturing in 2011, $198 billion is maturing in 2012, and $277 billion in 2013.
That's a lot of new paper to coax investors to buy.
Hopefully by then we will be enjoying a strong economy.