Capital Markets

Junk Default Rate at 20-Year Low

The global junk-bond default rate will inch up sometime this year, according to Standard & Poor's; prospects for the United States are a little les...
Stephen TaubMay 12, 2006

Standard & Poor’s has reported that the speculative-grade bond default rate for companies worldwide fell to a record low 1.08 percent at the end of April. The rate was 1.66 percent in the United States, added the ratings agency, and zero in Europe.

The default rate has now remained below the 1981–2005 average of 4.66 percent for 27 consecutive months, also dipping below the previous record of 1.28 percent posted only a month earlier.

Even though S&P expects the default rate to inch up sometime this year, the ratings agency stressed that its near-term global outlook is mostly sanguine due to expectations of relative economic stability, relatively favorable financing conditions, and healthy corporate profitability.

The agency is a little less upbeat on prospects for the United States, however. S&P expects that the U.S. junk default rate will climb to 2.6 percent by the fourth quarter and reach 4.6 percent by the end of 2007, very near the 25-year average.

S&P also noted that as of May 10, there were 18 what it calls “weakest links” — issuers rated CCC or lower with a negative outlook or with ratings on CreditWatch with negative implications — worth $6.9 billion. U.S.-based issuers accounted for 17 of the 18.

In fact, S&P and a number of hedge-fund managers warn that the U.S. default rate could surge during the next few years due to the recent issuance of low-rated paper. According to the ratings agency, a rising proportion of issuance B-minus or lower beginning in 2003 “serves as an early warning of renewed default pressure within two years.”

In the United States, the proportion of lower-grade issuance rose to 49 percent in April, from 40 percent in March. The ratio had averaged 44 percent in 2005, 47 percent in 2004, and just 30 percent in 2003. In Europe, for the four months ended April 30, the proportion of lower-grade issuance was 35 percent, down from 39 percent in 2005 and 45 percent in 2004.

The recent rash of low-rated paper might explain, in part, why high-yield bond mutual funds just reported their fifth straight week of net outflows of assets, according to Dow Jones, which cited AMG Data Services.