Capital Markets

Bond Defaults Fall for Third Straight Year

In addition, last year credit-rating upgrades exceeded downgrades for the first time since 1997.
Stephen TaubJanuary 25, 2005

Bond defaults in 2004 declined for the third consecutive year, as the global default rate for all rated corporate issuers fell to 0.7 percent from 1.7 percent in 2003, according to Moody’s Investors Service. As a percentage of dollar volume, the default rate declined to 0.4 percent in 2004 from 1 percent a year earlier.

In addition, last year credit-rating upgrades exceeded downgrades for the first time since 1997. The downgrade-to-upgrade ratio fell to 0.7:1 in 2004, from 2.4:1 the previous year; 14 percent of outstanding issuers received upgrades, while 9 percent received downgrades.

According to Moody’s, 34 corporate bond issuers that it rated as of January 1, 2004, defaulted on a total of $16 billion. All but four of the defaulters were based in the United States. Including five U.S.-based issuers whose ratings were withdrawn before January 1, a total of 39 Moody’s-rated issuers defaulted on $16.6 million of bonds.

By comparison, 80 corporate issuers defaulted on $34.2 billion in 2003, and 141 issuers defaulted on $163 billion in 2002.

Not surprisingly, the lowest tiers of the junk-bond category saw the greatest number of defaults. Issuers rated Caa and below, the five lowest notches on Moody’s 21-notch scale, defaulted at a rate of 12.3 percent last year. Issuers rated Ba defaulted at a pace of only 0.2 percent, while those rated B defaulted at a rate of 0.7 percent. Even so, these default rates were considerably below the long-run averages for those rating categories, the rating agency stressed.

Moody’s also warned, however, that the default rate could trend upward over the next few years, in large part because 16 percent of all new speculative-grade issuers last year were rated in the Caa-C range.

“This is a historic high proportion,” said director of default research David T. Hamilton, the author of the study. “While Moody’s currently doesn’t expect the default rate to rise sharply over the next year, the high proportion of Caa-and-below rated issuers will eventually put upward pressure on the aggregate default rate.”

Bear in mind that more than 40 percent of all junk bonds that came to market in 1998 defaulted within three years, and 74 percent of them have defaulted as of today, according to The New York Times. Currently, low-rated bonds account for 20 percent of outstanding junk bonds, more than twice the 1998 level, the paper added.