Junk Bond Defaults to Rise 5.6% in Next Year

S&P says continued stress on the energy sector from the oil price slump will drive defaults, offset somewhat by a likely delay in any interest rate...
Matthew HellerAugust 22, 2016

Defaults by issuers of speculative-grade debt will continue to increase over the 12 months to June 2017, driven in part by the continued stress on the energy sector from the oil price slump, Standard & Poor’s Ratings Services predicts.

In a new report, S&P forecasts the default rate will reach 5.6% by June 2017, following a 4.3% increase the previous year. To reach that rate, 99 speculative-grade issuers would need to default, compared with 79 issuers in the 12 months ended June 2016.

“Continued stress from the sustained decline in oil prices will likely remain a driver of defaults, though offsetting that slightly is the increased likelihood of the Federal Reserve delaying any interest rate hikes in the coming quarters,” S&P said.

Over the past year, both the number and percentage of defaults in the energy and natural resources sector have increased significantly. Since the start of 2015 through June 30, 2016, the sector has accounted for more than 57% of all U.S.-based defaults and 56% of the speculative-grade total.

“Thus far, there has been little spillover effect to other sectors, though we are not ruling out this possibility in the coming quarters,” S&P said.

The ratings service noted that expectations for any near-term interest rate increases by the Fed are decreasing amid mixed economic data in recent months. As a result, borrowing costs should remain “subdued for most corporate borrowers in the U.S. as investors’ search for yield guides them toward speculative-grade bonds.”

Also benefiting speculative-grade issuers, S&P added, are bond spreads that continue to decline and the potential for distressed oil and gas companies to find funding from alternate sources, such as hedge funds or private equity firms — “all of which could help default occurrences to stabilize.”

At the end of July, speculative-grade bond spreads fell to 560 basis points from a high of 815 bps on Feb. 16. “This falling ‘spread’  means investors are pouring money into the most speculative bonds looking for yield and are willing to accept a lower premium for the risk they are taking,” USA Today explained.

4 Powerful Communication Strategies for Your Next Board Meeting