Capital Markets

Junk Market Hits the Skids

Distressed ratios are at their highest level since 2003, says S&P. Plus, downgrades are forcing companies to rework balance sheets.
Stephen TaubMarch 25, 2008

The long-predicted deterioration in the junk bond market is finally materializing. The distressed ratio surged more than five percentage points to 22.2 percent in March, from
16.9 percent the prior month, according to a new report from Standard & Poor’s. The ratio is now at its highest level since April 2003. Interestingly, the ratio stood at just 0.8 percent one year ago.

Distressed credits are defined as speculative-grade rated issues that have option-adjusted spreads of more than 1,000 basis points relative to Treasury bonds. The increase in the distress ratio comes at the same time that speculative-grade bond spreads continue to widen. They rose nearly 50 basis points in one month, to 763 basis points on March 13 from 714 points on February 15.

S&P blames much of this month’s increase in the distress ratio on the more than $39.5 billion of senior unsecured issues backed by GMAC LLC and Ford Motor Credit Co. In February, only one issue from GMAC — at $2 billion — was trading at distressed levels. Currently, the two companies have a combined 32 issues trading with spreads over 1,000 basis points relative to Treasuries.

The leveraged-loan market also experienced a rapid run-up in its distress ratio in February. The S&P/LSTA Leveraged-Loan Index distressed ratio nearly doubled to 13.7 percent from 6.9 percent in January. This is the highest monthly reading since the series began in January 1997. The index published by a partnership between S&P and the Loan Syndications and Trading Association.

S&P also noted that at least one-quarter of all speculative-grade rated securities in eight nonfinancial sectors are now trading at distressed levels, with the media and entertainment sector leading the way at over 32 percent.

In a separate report, S&P pointed out that so far this year, downgrades have outpaced upgrades 3 to 1. “On balance, credit metrics, which have been relatively benign even when the market disruption began last summer, are now beginning to show stress associated with an economic slowdown,” the credit rating company said in a report. “We expect to see more downgrades as sluggish profit growth deteriorates leading financial indicators.”

It is little wonder then that only nine rated deals have come to market so far this year. “Corporate firms are being forced to rethink their balance-sheet management strategies because of rising borrowing costs and excessive market volatility,” S&P noted. Indeed, Bloomberg pointed out that high-yield bonds are off to their worst start ever, falling an average 3.9 percent so far this year.