Moody's sees junk bond default rate soaring
By Jonathan Stempel
NEW YORK (Reuters) - The rate of junk bond defaults rose to 5.43 percent in the second quarter from 4.82 percent a year earlier and will soar to 8.4 percent next June as credit quality drops, threatening the survival of many companies, credit rating agency Moody's Investors Service warned Friday.
Top junk bond experts, however, called Moody's overly pessimistic, and one said junk bonds offer investors legitimate prospects for solid total returns in the next year.
The second-quarter default rate was the second highest since 1991 as calculated by Moody's, which is considered conservative in its assessments.
Moody's said the default rate, which rose last year, will surge as more financial problems hit low-rated companies that sold junk bonds in 1997 and 1998, when investor risk tolerance was ``extremely high.''
David Hamilton, the Moody's analyst who wrote the report, said some Wall Street commentators labeled last year's surge a one-time event. Indeed, the rate dipped early this year.
``Moody's has maintained that the brief lull in defaults at the beginning of the year represented a Trojan Horse, and that it would not take long for (companies) to surprise the market and again start defaulting,'' he wrote. ``This prediction is proving to be prescient.''
Junk bonds carry ratings of Ba1 or lower from Moody's and are considered to carry high ownership risk.
OVERLY PESSIMISTIC?
Edward Altman, the Max L. Heine professor of finance at NYU's Stern School of Business and an expert on junk bonds, said Moody's projections are overly pessimistic.
``I would expect the rate to be in the vicinity of 5 to 6 percent for calendar year 2000, and perhaps go even slightly higher by the middle of 2001,'' he said. ``I find 8.4 percent on the high side. That's huge.''
And Gregory Peters, head of high yield strategy at Salomon Smith Barney, said ``it's our opinion that we will look at the default rate running in the 4.5 to 5 percent range.''
Altman last week issued his own report showing a 5.22 percent trailing 12-month default rate. He said banks are tightening credit standards, making it more difficult for companies with marginal credit quality to refinance short-term debt as it comes due.
How much banks tighten, he said, is significant to the 17 percent of junk bonds that are ``distressed'' -- yielding at least 10 percentage points more than comparable U.S. Treasuries. He said a ``fair proportion'' of these will default.
Still, he said if the default rate is in fact cresting, now could be a good time for investors to buy junk bonds.
Junk bonds are showing signs of recovery, having posted total returns above 2 percent since June 1, according to Merrill Lynch & Co.
Altman noted that in 1991 the default rate topped out at 10.3 percent and junk bond investors enjoyed 43 percent total returns.
``I'm expecting the rate to peak in less than a year, if it hasn't already,'' he said. ``When that happens, there will be a lot of money to be made in the high-yield bond market for those companies that do not default.''
9.6 BILLION DEFAULTED
Moody's said 37 companies it rates defaulted on $9.6 billion of debt in the second quarter. That compares to 23 companies defaulting on $7.4 billion in the first quarter, when the annualized default rate was 5.66 percent, Moody's said.
The amount that went into default in the second quarter surpassed the $8.7 billion in new junk bonds sold during the period, according to Thomson Financial Securities Data.
No industry dominated second quarter defaults, Moody's said, and 72 percent of defaulting companies, accounting for $8.3 billion of debt, were based in the United States.
Key to Moody's report is the concept of ``aging.'' Moody's said companies are most likely to default on bonds 3.5 years after they sell them.
Peters said that in fact companies are defaulting faster. ''Issuers are defaulting sooner, often in their first two years,'' he said. ``We're paying now for the excesses of 1997 and 1998, when money was easier to get. It is unreasonable to expect the default rate will keep rising as bonds mature.''
In an interview, Hamilton said many of the dicier credits that most benefited from this excess have already defaulted. ''The survivors are now entering the point where, historically speaking, the risk of default is highest,'' he said.
15:20 07-14-00 |
