Capital Markets

Can Junk Bonds Get any Junkier?

S&P reports that downgrades outnumbered upgrades by 13 to 1 in November and the first half of December.
Stephen TaubDecember 29, 2008

The investment-grade bond market may be slowly thawing, but the junk bond market remains all but frozen, and it’s not hard to see why.

Credit quality among U.S. speculative-grade issuers continued to deteriorate in November and early December, with 131 downgrades to just 10 upgrades since the end of October, Standard & Poor’s pointed out in a new report.

Total downgrades for the year reached 518 as of Dec. 17, the most since 2001. What’s more, the 311 downgrades in the second half of 2008 make the highest second-half total ever, already eclipsing the total of 308 in 2001. “We expect downgrades to continue at this pace in the first half of 2009,” S&P predicted in a new report.

The percentage of issuers with negative bias — those designated as “CreditWatch negative” or with a negative outlook — has climbed to 37.5 percent, nearly a six-year high.

In addition, there were 11 defaults in November, which pushed the 12-month-trailing speculative-grade default rate up to 3.15 percent, from 2.86 percent in October; and there were eight more defaults in the first half of December. “Defaults are expected to continue to rise over the coming months,” S&P warned.

The ratings agency noted that 15 percent of speculative-grade parent issuers currently are rated B-, and 9 percent are rated CCC+ or lower. It added that it expects the 12-month trailing issuer-based high-yield default rate to rise to between 7.6 percent and 9.6 percent, with the pessimistic scenario “growing ever more likely.”

Small wonder, then, that the average spread between high-yield issues and Treasuries rose to 1,713 basis points on Dec. 23, up from 1,590 basis points at the end of November and 1,383 points at the end of October. “Much of the recent move in high-yield bond spreads has stemmed from the unprecedented drop in Treasury yields and less to do with a decline in high-yield bond prices,” S&P explained.

The total number of rated companies with issues trading with spreads of 1,000 basis points and higher is currently 540, up from 488 a month ago, S&P noted in a separate report. As a result, the distress ratio hit an all-time high of 85 percent on Dec. 15.

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

Leveraged loans have also gotten more distressed. The S&P/LSTA Leveraged-Loan Index distress ratio increased sharply, to 75.8 percent in November from 66 percent in October, reaching the highest level since that metric was created in January 1997.

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