Junk Bond Defaults Set to Soar
Companies rolling over debt will find the lending climate harsh for anything rated speculative -- but improving for investment grade.
By Jerome Idaszak, Associate Editor, The Kiplinger Letter
February 4, 2009
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Defaults on speculative-grade corporate bonds will skyrocket in 2009 to about a 15% annual rate. That's well above 2008’s 4% rate and the record 10.7% set in 1991. Making the situation worse is a severe recession and the huge load of maturing speculative- and investment-grade debt this year -- about $760 billion, or 12% of outstanding U.S. corporate debt.
Approximately 40% of the bonds due to mature are rated speculative, and companies will have to pay high rates to roll over the debt. Rates are around 17%, up from 9% a year ago. Yields on bonds rated investment grade aren't as high, averaging 8%. But that's still five percentage points above comparable Treasury debt, a gap that typically is about two percentage points. And businesses face competition with the Treasury, which has its own huge financing load in light of a federal budget deficit expected to hit $1.2 trillion this year.
Defaults on debt and resulting bankruptcies are “downside risks,” among the conditions that threaten to worsen the credit crisis and extend an already severe recession, according to Stuart Hoffman, chief economist with PNC Financial.
Among investors, a general aversion to risk makes for a big obstacle for debt-laden companies. Diane Vazza, managing director of global fixed income research for Standard & Poor's credit rating agency, says that the lowest-rated companies will be highly challenged to find buyers even at these high yields.
The climate for high-quality borrowers seems to be improving, Vazza says. The volume of bond deals picked up in December and January. Meanwhile, the spread against Treasuries has narrowed by a full percentage point since mid-December. Amgen, for example, was able to sell 10-year bonds yielding 5.7% in January, a more favorable rate than the 6.17% the company sold bonds at in May.
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Reader Comments (1)
Posted by: Planetoid20 at 01/23/2010 04:50:48 PM
Dear Jerome Idaszak: I am an individual investor with some investment in corporate bonds, mainly investment grade. I find the information in your article to be of little value for investment purposes primarily because of a lack of direct applicability to investment decisions. Bond default rates can be expressed in at least two different forms (i.e., issuer denominated and dollar denominated) and your article does not indicate which, if either, of those two you are using. Furthermore, default rates themselves are not directly helpful to investors in making investment decisions about corporate bonds. What bond investors could use directly in making bond investment decisions would be the promised yield to actual yield spread for various classes of bonds. The promised yield is the yield to the bond holder that would result if the bond issuer does not default on the bond. The actual yield is the same as the promised yield if no default occurs. If the issuer defaults, the actual yield is the resulting yield to the unfortunate bond holder after taking into account any recovery of principal that may have occurred at the final settlement of the defaulted bond. If some of the bonds in a class of bonds default, then the actual yield for that class will be somewhat less than the promised yield for that class. The difference between the two is the spread. Knowing what the past promised to actual yield spread is for a class of bonds would help an investor aiming to achieve a given return on his investment in bonds. Sincerely, Planetoid20