S&P Sees Rising Junk Bond Defaults Despite Better Market
Despite the recent improvement in market conditions, Standard & Poor’s continues to expect deterioration in junk bond credit quality. Investors have, at least temporarily, regained interest in high-yield bonds, as fear and market volatility subsided after peaking in late March, S&P says in its latest Credit Trends report for the sector.
“There was $16 billion of issuance by mid-May. Leveraged-loan backlogs from 2007 have been cut almost in half, taking pressure off both the loan and bond markets. We expect that broker/dealers will continue to use the window opened by the recent rally to move paper slowly into the market.”
Despite this positive news, lending conditions are still very tight, and capital is not easily obtainable for weaker credits, S&P says. A net 55.4% of domestic banks report tighter standards for large and medium commercial and industrial loans, which is up from 32% in the first quarter and 19.2% in the fourth quarter of 2007.
Downgrade risks are elevated, and the pace of downgrades has accelerated in 2008.
Default pressures mount as more firms are exercising payment-in-kind features, i.e., paying bondholders with additional securities instead of coupons. In addition, some companies are negotiating and looking for covenant extensions with lenders or attempting to set up distressed debt exchanges. All three foretell more defaults to come, S&P says.
The trailing-12 month speculative-grade default rate increased to 1.64%, with nine (including two confidentially rated issuers) U.S.-based companies defaulting in April.
We expect the trailing-12 month speculative-grade default rate to climb to 4.7% four quarters out.
More details are available in Credit Trends: U.S. High-Yield Prospects: Market Conditions Improve, But Default Risk Continues To Rise.
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