Capital Markets

The Vultures Are Circling

The ratio of distressed debt soars to its highest level in five years.
Stephen TaubJanuary 28, 2008

It’s beginning to look a lot like a recession. The U.S. distressed-debt ratio leaped by five percentage points to 11.1 percent in January, from 6.1 percent in December, according to a new report from Standard & Poor’s.

The ratio is at its highest level since September 2003, and the increase from the previous month was the greatest since October 2002, according to the debt rater.

As of Jan. 15 distressed issues cumulatively affected debt worth $64.5 billion, nearly $30 billion higher than in December.

Distressed credits are defined as speculative-grade rated issues that have option-adjusted spreads of more than 1,000 basis points relative to Treasuries.

S&P noted that the increase in distress follows continued widening in the spreads of non-distressed speculative-grade bonds, which rose nearly 100 basis points in one month to 637 basis points on Jan. 15, from 541 basis points on Dec. 12.

S&P last week forecasted that the U.S. speculative default rate will more than triple, to 3.4 percent, by the end of December.

It’s small wonder, then, that private equity funds and hedge funds that specialize in distressed securities are talking up this asset class as the number-one opportunity to mine for investments over the next couple of years.

Indeed, at the beginning of January — before the latest S&P data was disclosed and before the global stock markets tanked — 20 percent of 41 hedge fund executives managing $227 billion said in a survey conducted by Lipper Inc. that distressed investing will be the top strategy over the next year.

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