S&P says corporate bond defaults rise
By Jonathan Stempel
NEW YORK, July 18 (Reuters) - Companies are defaulting on their debt faster than at any time since 1991 and are highly vulnerable to rising interest rates or slowing U.S. economic growth, the credit rating agency Standard & Poor's warned Tuesday in a new report.
The agency said, however, that the default rate may be near a peak, and could decline within two to three years.
S&P said 60 companies defaulted on $19.8 billion of debt in the first half of 2000. Fifty-eight of these companies, S&P said, were based in the United States or Canada.
In comparison, in the first half of 1999, 54 companies defaulted on $22 billion of debt.
The "dismal record" is "by far the worst of any half year," wrote Leo Brand, an S&P director.
Brand warned that a sharp increase in interest rates "would probably push many a highly leveraged company over the edge" and that a downturn in the economy could put "enormous" pressure on low-rated companies.
"Some of them might not survive," he wrote.
S&P joined its top rival, Moody's Investors Service, in warning of the risks of corporate bond defaults.
Moody's, which issued its own report last Friday, said the rate of junk bond defaults will rise to 8.4 percent by next June from 5.43 percent in the second quarter of this year.
S&P, which calculates default rates differently, said the annualized rate for the year's first half was 2.4 percent.
Junk bonds carry ratings of BB-plus or lower from S&P and Ba1 or lower from Moody's, and are considered to carry high ownership risk. Defaults by higher-rated companies are extremely rare, and the 60 defaulting companies that S&P identified carried junk grades.
YOUTH A FACTOR
The biggest rated default in the first half, S&P said, came from Genesis Health Ventures Inc. The Kennett Square, Pa.-based long-term care service provider defaulted on $2.1 billion of debt, S&P said. It filed for bankruptcy last month.
In addition, S&P said, Safety-Kleen Corp., the Columbia, S.C.-based industrial waste service company, defaulted on $1.9 billion, while its largest shareholder, Burlington, Ontario-based bus company Laidlaw Inc. <LDW.N> <LDM.TO>, defaulted on $1.5 billion.
Most of the defaulting companies, S&P said, are young. S&P said it first rated more than 60 percent of them after 1996.
Indeed, in 1997 and 1998 there was a surge in issuance of highly speculative bonds. That was a period when many low-rated companies took advantage of an investor risk tolerance now considered very high.
Edward Altman, the Max L. Heine professor of finance at NYU's Stern School of Business and an expert on junk bonds, said the recent surge in the default rate has "more to do with the huge amount of issuance with deteriorating credit quality, and also the leveraged loan market, than the fact that companies are earning less money."
S&P said the average time it takes a company to default after first being rated is 4.5 years. Other experts put the median time it takes companies to default at about 3.5 years.
AT A PEAK?
S&P remains optimistic the default rate will fall.
Investors' previously "ravenous" appetite for risk is subsiding, Brand wrote. Moreover, the percentage of new companies carrying junk grades is declining sharply, after rising throughout much of the 1990s. Those factors, he wrote, may cause the default rate to decline by 2003.
NYU's Altman this month completed his own study showing a first half default rate that, annualized, would total 5.22 percent. He said the rate should peak within a year, if it hasn't already, and that when it does many junk bond investors will be able to enjoy solid total returns.
One thing to keep an eye on, he said, is the Federal Reserve, which has raised interest rates six times since last June. Unlike in 1991, when the default rate surged as the United States suffered through a recession, the rate is now on the rise while the country enjoys solid economic growth.
That, said Altman, could lead to a surprise.
"If the increase actually impacts Fed policy with respect to the economy, it could have a profound impact on the overall economy in the future," he said. "If it means the Fed won't increase interest rates as much, it could actually help the economy rather than hurt it, even though that seems perverse."
18:02 07-18-00 |
