Good News in HY: Defaults May Ease

The plague of bond defaults that infected the high yield corporate bond market in the last year may be at last in remission, according to Wall Street analysts.

Both Salomon Smith Barney and Credit Suisse First Boston analysts predict that the annual default rate will substantially decline this year to about 3.0%, and remain below average for much of the early part of the decade. It's a far cry from the dire predictions of less than six months ago, when some market players saw no end in sight to what had become a series of vicious spikes in default rate levels.

The soaring number of defaults in last year's junk market (according to Salomon, the year ended with a 4.15% bond default rate) helped poison the well for high yield. Default fears contributed to the bonds' general underperformance, hurt some Street shops' market shares, and inspired a wave of fatigued investors to flee the market in the latter half of the year.

The August collapse of longtime junk issuer Iridium LLC kicked up what had already been a steady increase in bond defaults since the market crisis of September 1998. Bond defaults stood at 3.46% at the beginning of 1999, but after the Iridium debacle, rates shot up to 5.3%. By year's end, a record $23.6 billion in high yield debt had defaulted. Many analysts, fearing the worst, predicted last fall that junk bond default rates would hit more than 6% by early 2000.

The rise of defaults in 1999 shook up many longtime observers of the junk market as many of the defaults were coming from seasonal issues, which traditionally had been expected to post low default rates. The woes of specific industries, especially energy, satellite communications and healthcare, also exacerbated the situation.

However, the market at last seems to be stabilizing, and analysts now predict the rate should drop to the 3.0% range this year. What has helped the market immensely has been the buyside's disinclination for poor quality, unknown deals, which has shut some inferior issuers out of the market. Further, most of the battered industries, especially energy, seem to be back on track.

Salomon analysts, for example, predict $17.5 billion in total defaulted debt for this year, representing a rate of about 2.7% on a $650 billion combined U.S./Europe high yield market.