Canadian companies have fared rather well, despite the turmoil in global credit markets, according to a report from Moody’s Investors Service. However, the report says that 2007 was probably the low of the latest credit cycle, and that defaults will increase in the months ahead.

Only two Canadian corporate issuers defaulted during 2007, the report notes, affecting a total of $229 million of bonds and $310 million of loans in 2007.

“Compared to the historical average of four defaults per year, 2007’s default count of two was relatively low. Total default volume for rated and unrated issuers was $539 million in 2007, which was also well below the long-term average of $2,455 million between 1989 and 2006,” says Moody’s analyst Sharon Ou, author of the report.

“Although defaults have been pretty low in the last couple of years, we believe those lows likely mark the bottom of the current credit cycle. In fact, three Canadian issuers have already defaulted on a total of $1,645 million of debt in the first five months of 2008. This year’s default count and volume will undoubtedly exceed those in 2004-2006,” adds Ou.

Additionally, Moody’s report shows that Canadian issuers’ overall credit quality deteriorated in 2007. The upgrade-to-downgrade ratio fell from 0.9 in 2006 to 0.4 in 2007, which is below the long-term average of 0.7 since 1989.

Among speculative-grade issuers, the sole 2007 rated defaulter lifted the default rate to 1.2% from zero percent from 2004 to 2006 as there were no Moody’s-rated Canadian defaults in those three years. Looking ahead, Moody’s Credit Transition Model predicts that the Canadian speculative-grade default rate will rise sharply to 7.2% by the end of 2008 then decline to 6.1% by the end of April 2009, both levels are well above the average rate of 3.6% over the last 19 years, but also well below the peak of 13.8% in September 2001.

“The primary factors putting upward pressure on default rates are deteriorated credit quality, a weak U.S. housing market, weakening U.S. consumer demand, and increasing energy prices (affecting the auto sector amongst others). Weaker global economic conditions, widening credit spreads and tougher corporate underwriting standards will together hinder the ability of many speculative-grade issuers to make debt service payments and re-finance maturing debt,” says Ou.

For investment-grade issuers, Moody’s CTM forecasts that 3.7% of Canadian issuers will become fallen angels in the coming 12 months, which is above the average of 2.4% since 1989.