(July 10) – “Even some of the optimists on the outlook for junk-bond defaults are saying: Never mind,” writes Paul M. Sherer in today’s Wall Street Journal.
“Donaldson, Lufkin & Jenrette Inc., the biggest underwriter of junk or “high-yield” bonds — which until recently was preaching a don’t-worry gospel on defaults — now isn’t so sanguine. It says the U.S. is in a credit crunch, which means companies unable to raise funds from increasingly cautious lenders are being forced into default.”
“‘We see a systematic crowding out of more risky assets, [and] smaller issuers [aren’t] able to access the capital markets,’ says Sam DeRosa-Farag, DLJ’s director of global high-yield portfolio strategy. ‘That is the classical credit crunch.’ Only $8 billion in junk bonds were issued in the second quarter, down from $31.4 billion in the same period of 1999.”
“Put another way, more junk-bonds defaulted in the second quarter than were issued. About $9.4 billion in bonds defaulted in the quarter, issued by companies ranging from cinema operator United Artists Theatre Co. to waste-management company Safety-Kleen Corp., along with several companies that were originally investment-grade issuers, such as bus operator Laidlaw Inc.”
“Prominent junk-bond researcher Edward I. Altman at New York University’s Stern School of Business, who at the start of the year had expected 3% of junk bonds to default in 2000, now expects several more quarters of high defaults after the first half ended with an annualized 5.22% default rate.”
“‘It appears that the recent spike in default rates has some time to go before the excesses of new-issue, low-quality debt in the mid and late 1990s will be flushed out of the system,’ says a new report by Prof. Altman. ‘We can probably anticipate at least several quarters more of continued high default levels.’ The report was published by Citigroup Inc.’s Salomon Smith Barney, where he serves as a consultant.”
“The growing pessimism on defaults comes as the U.S. shows signs of approaching the end of a credit bubble. After years of soaring corporate and consumer debt, a series of interest-rate increases and growing caution on the part of lenders have begun to squeeze shaky borrowers.”
“Meanwhile, some key indicators of future defaults have turned downward. Mr. DeRosa-Farag notes that the ratio of credit-rating upgrades to downgrades has dropped sharply, from a historical average of 1.2 upgrades per downgrade to 0.65 last year and 0.4 last month. ‘The trend is alarming us,’ he says.”