Crossover prices indicate default rate up to 50%

By Jane Baird

LONDON, Oct 23 (Reuters) - Fresh record levels for Europe's Crossover credit derivatives index of 50 mostly junk-rated companies are pricing in expectations that one-third to as many as one-half of them will default over the next few years.

High-yield spreads have widened dramatically this month as investor attention has shifted from the acute stress of the financial crisis to concerns about the longer-term prospects for non-financial companies.

The Markit iTraxx Crossover index ITEXO5Y=GF has hit a series of records in the past two weeks, taking it from around 566 basis points on Oct. 1 to near 820 basis points on Thursday.

At 800 basis points, the index implies a loss of 33 percent. At a zero percent recovery rate, that would mean about one-third of its companies default. At a historical average recovery rate of 40 percent, that probability of default rises to 50 percent of index companies. [ID:nLK176512]

Europe's high-yield, non-financial companies do not face an imminent threat of running short of cash, analysts say.

"Near-term liquidity is not the problem, but for these highly leveraged businesses, the question is what's going to happen in two or three years," said Robert Jones, head of high-yield research at Barclays Capital.

The challenges include: a likely prolonged global economic slump that could shrink earnings and cash flows; a high-yield bond market that has already been shut for more than a year and is likely to remain closed for years to come; the bulk of debt repayments starting from 2010 and 2011; and, before then, a risk of breaching covenants -- committed financial targets -- at a time that lenders are less inclined to be forgiving.

"We have got to this point (to current spreads) because of a rush for the exits, and because people do not want to add risk," said Suki Mann, head of credit strategy at SG CIB.

"It has been mostly a technical issue, but it is now merging into a fundamental one," he added.

JUMP IN UPFRONT TRADING

In another measure of stress, the number of Crossover members trading upfront have jumped to 12 from seven this week.

Upfront status indicates that the perceived risk of a jump to default is so high that most of the cost must be covered by a downpayment instead of five annual payments.

"Trading upfront historically meant that companies were in distress; it doesn't necessarily mean that anymore," said Chris Ucko, an analyst with independent research firm CreditSights.

"CDS pricing is showing an increased likelihood of default everywhere," he added. "It is also showing a complete evaporation" of investor interest in taking credit risk.