Capital Markets

Junk in Best Shape in 26 Years

Standard & Poor's measure of junk bond distress has fallen to its lowest level since 1980.
Stephen TaubDecember 28, 2006

The metric by which Standard & Poor’s measures the overall level of distress among junk bonds has fallen to a 26-year low, continuing to confound experts who have been expecting to see defaults on the rise.

A corporate bond is considered “distressed” debt if it has an interest rate that is 1,000 basis points (bps) or more over its respective Treasury benchmark. S&P’s bond distress ratio is defined as the number of speculative-grade issues with option-adjusted spreads above 1,000 bps divided by the total number of speculative-grade issues. A rising distress ratio signals increased urgent need for capital by companies most in need, says S&P, and is potentially a precursor to higher defaults, if accompanied by a credit crunch.

The credit rating company said the distress ratio in the U.S. speculative-grade bond market fell to 1.6 percent in December. That is down from the 2006 high of 5.7 percent reached in February, according to the report. It is also way off from the 6.1 percent average recorded in 2005 and 7.4 percent in 2004, according to S&P.

The average distress ratio for 2006 currently stands at a 3.7 percent, the lowest annual average since the 1997 level of 3.3 percent.

Market experts and hedge fund managers who specialize in investing in distressed paper have been forecasting a rise in the US distressed ratio for the past year amid overall concerns that credit quality is eroding.

In the United States, the automotive and health care sectors have continued to show the highest propensity for distress as a share of total speculative-grade rated issues, according to S&P. Following behind health care was the retail/restaurants sector.