Junk Defaults, Downgrades Jump During 2Q


Proving the predictions of several market players, high-yield defaults continued to rise during the second quarter, according to statistics from a soon-to-be-released report by Moody's Investors Service.

At the end of last month, Moody's speculative-grade, trailing 12-month default rate stood at 4.27%, compared with just 3.3% at the end of December 1998. While the current rate isn't alarming, it does exceed the range of historical norms. Moreover, defaults could sustain their upward trend if banks tighten their underwriting standards.

Gulf States Steel, for example, was unable to make its $12.8 million coupon payment in April on a 13.5% issue. And earlier in the year, apparel companies Brazo's Sportwear and Salant Corp. both were in default.

But what's perhaps more noteworthy than the default rate itself is looking at which types of issuers contributed the defaults. According to Moody's, the typical defaulter during the first half of 1999 had rated debt outstanding for 5.1 years, which means 1994 issues were the biggest culprits.

That's surprising given the fact that most investors expected that this year's defaults would be linked to the market excesses of 1997, when low-rated credits were able to price deals in a frothy market. Now, of course, that euphoria in the junk market is long gone, and many of 1997's issuers are struggling.

While the days of 1997 are generally expected to increase the number of defaults over the next couple of years, it is difficult to predict the future default rate because the universe of high yield issuers has increased along with the defaulters. Essentially, that increased both the denominator and the numerator of the ratio.

Yet another surprise, though, comes from the geography of the defaults. About 77% of those issuers that did not make coupon payments were based in the U.S. and Canada instead of abroad. At the beginning of the year, many people were expecting a rise in the defaults coming from corporate issuers in emerging markets, especially in Asia (HYR 01/11/99).

"With the exception of the U.S. and Canada, there doesn't appear to be any systematic pattern of weakness," said Sean Keenan, a Moody's senior analyst who compiled the report.

Other market numbers back up the Moody's picture. According to Standard & Poor's, not only did defaults rise in the first part of the year, but the number of investment-grade issuers downgraded to junk-bond status - the other indicator of credit quality - increased as well. (The numbers from Standard & Poor's are for the first five months of 1999.)

The ratio of upgrades to downgrades declined to 0.147 in the first five months of the year; down from 1.129 in 1998, S&P said. The ratio has not been that low since it bottomed out in 1990 at 0.237.