Capital Markets

Junk Defaults at Low, Low Levels

From a January 2002 high of 10.9 percent, the global default rate for speculative-grade issues fell to 2.2 percent in December.
Stephen TaubJanuary 7, 2005

For the high-yield market, this may be as good as it gets.

During the past year, the global default rate for speculative-grade issues fell from 5.2 percent at the beginning of 2004, to 2.4 percent in November, to December’s 2.2 percent, according to Moody’s Investors Service. The default rate hit 10.9 percent in January 2002, during the continued fallout from the dotcom bubble and not long after the September 11 attacks.

The very low default rate coincides with a record year for issuing speculative-grade debt, as strong investor demand caused the spread between high-yield bonds and safer bonds to narrow considerably.

Looking ahead, Moody’s expects the default rate to decline further, to 1.8 percent, around the beginning of the second quarter. By year-end, however, the rating agency expects the rate to climb to 2.7 percent.

“The improvement in aggregate credit seems to be slowing somewhat,” said David T. Hamilton, director of corporate default research at Moody’s, in a statement. “The default rate is at levels not seen since the high growth period of the mid-1990s, so further declines are limited.”

Further, last year the proportion of CCC-rated debt rose to 17.1 percent from 8.7 percent in 2003 and just 2.8 percent in 2002, according to the Financial Times, suggesting that more outstanding junk paper could be shaky given a tenuous economy.

The largest default last year, affecting about $4.7 billion of bonds outstanding, was by Level 3 Communications took place in December. That same month, Russian oil giant Yukos defaulted on more than $1 billion of bank loans; although it carried a Moody’s issuer rating at the time, it did not have any bond debt, so its default did not affect the default rate, the ratings agency pointed out.

Altogether, 38 issuers defaulted on $15.9 billion of bonds last year; 35 were based in the United States. A year earlier, 80 issuers defaulted on $34.3 billion of bonds; 60 were U.S.-based.

For the fifth straight year, the telecommunications industry had the dubious distinction of contributing the highest default volume, with a total of $6.1 billion in bonds. Other industries with relatively high default rates included hotels/casinos/gaming and electric utilities.

The average recovery rate for defaulted senior unsecured bonds reached 57.8 percent, the highest annual average on record. From 1982 through 2004, the rate averaged 41.2 percent, Moody’s pointed out. “The rise in recovery rates was experienced at all levels of the capital structure,” said Hamilton, noting that average recovery rates typically increase in years when the default rate falls.