Risk

Junk Bond Default Rate to Hit 3.3%

S&P warns the speculative-grade market will be under pressure from a "near-certain" hike in interest rates.
Matthew HellerNovember 17, 2015

Defaults by issuers of speculative-grade debt will continue to increase over the 12 months to September 2016, fueled in part by a “near-certain” hike in interest rates, Standard & Poor’s Ratings Services predicts.

While still relatively low by historical standards, the default rate in the market for debt rated BB+ or lower has been on the rise since 2014. In a new report, S&P forecasts it will reach 3.3% by September 2016, following a 2.5% increase the previous year.

“Stressors in the form of persistently low oil prices, a now as near-certain interest rate hike by the Federal Reserve … and slower global growth likely will produce more defaults in the next 12 months,” the report says, adding that “the current crop of U.S. speculative-grade issuers appears fragile, and particularly susceptible to any sudden, unanticipated shocks.”

Issuers rated ‘B-‘ or lower now account for 19% of all speculative-grade issuers, the highest level in nearly five years, S&P noted.

“While we expect the Fed to carefully manage the process of raising interest rates, market reactions could be more volatile than anticipated,” the rating agency warned.

The recent low rate of defaults has reflected in part surplus liquidity. For all of 2014, $231.3 billion of new U.S. speculative-grade bonds came to market, after $275.2 billion in 2013, and a record high of $291.8 billion in 2012.

But according to S&P, “signs of stress are starting to appear.” In the four months since since June 30, for example, only $42.9 billion of speculative-grade debt came to market, compared with $75 billion in the second quarter of 2015.

If interest rates do rise, the report says, companies that issued more debt to finance leveraged buyouts, share buybacks, and increased dividends, rather than using this funding for business growth, could be particularly vulnerable.

A rate hike will force weaker companies “to pay investors more to buy their debt,” ETF Daily News said Monday. “And many won’t be able to afford it.”