High Refunding Risk Spurs Spike in Junk Bond Defaults
Fueled by “very high” refunding risks and other factors, the default rate on US speculative grade bonds is expected to quadruple to over 16% by November, compared with 4.4% last November and only 1% in 2007.
According to Moody’s , refunding risk, measured by market conditions and ratings, for U.S. speculative-grade companies is very high due to the continuing turmoil in the credit markets, general lack of market liquidity and weak economic conditions.
Refunding risk is magnified by investors’ flight to quality and by banks’ cautious approach in lending to lower-rated speculative-grade companies.
Other key points:
- Refunding needs for rated U.S. issuers over the next three years have more than doubled to $190 billion compared to $86 billion in last year’s study; this is the highest the refunding needs have been since the inception of this annual study 11 years ago.
- Refunding risk for the 2009 maturities is particularly high, despite refunding needs being less than the 2010 and 2011 maturities, due to the current weak credit market environment. However, these maturities are almost evenly distributed throughout the year, thereby spreading the risk, although more lower-rated companies have maturities in the first half of the year than in the second half.
- With the flight to quality witnessed in today’s markets, lower ratings equate to a substantial increase in refunding risk for lower-rated speculative-grade companies with 23% of the $26 billion maturing in2009 having instrument ratings of Caa1 or lower.
- The default rate for U.S. speculative-grade issuers is expected to increase sharply to 16.4% by November 2009 versus 4.4% in 2008 and 1% in 2007. The higher expected default rate is due to eroding liquidity at many companies and decisions to restructure balance sheets (potentially engaging in a distressed exchange).
Moody’s report Moody’s Refunding Risk and Needs for U.S. Speculative-Grade Corporate Issuers, 2009-2011 also includes a complete listing of maturity dates for US speculative-grade corporate bond issues.
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