Has the Junk Default Rate Bottomed Out?

For speculative-grade debt, February's rise in the default rate ''may indicate that we are near the turning point,'' according to one ratings agency.

Moody’s Investors Service reported that the global speculative-grade default rate moved up slightly in February, to 2.5 percent, from 2.3 percent in January.

The rating agency speculated that this could signal a turning point in the direction of the default rate.

“For several months now, Moody’s has been predicting that default rates would reach a cyclical low near the second quarter of this year,” said David T. Hamilton, Moody’s director of default research. “February’s rise may indicate that we are near the turning point. Our default forecasting model indicates that the default rate will gradually increase over the first half of this year, break higher in the last six months, and reach a 3.2 percent level by the end of February 2006.”

Even so, Hamilton is confident that the default rate will probably remain below its historical annual average. “Even in a high-default scenario, with default counts running 50 percent higher than we are currently forecasting, the default rate still would not quite reach the 4.9 percent historical average,” he added.

Despite concerns about a potentially rising default rate, The Wall Street Journal reported that market pros expect new issuance of junk bonds to rise in the near future. “People have a lot of money to invest; there’s no evidence yet that deals are struggling,” Matt Freund, portfolio manager of three USAA bond funds with $1 billion in assets, told the paper. “It’s easier to sell bonds right now than buy them.”

So far this year, there have only been $23.6 billion of new deals, down from $28.6 billion at the same time last year, according to the paper, citing data from Thomson Financial. This week, however, $2.5 billion in high-yield bonds are expected to be issued, according to the Journal.

Issuers, of course, need willing investors. Last week, high-yield bond funds reported $96.26 million of outflows in the most recent week, according to the Journal, citing information from AMG Data Services. The asset class has now suffered outflows in 11 of the 12 previous weeks.

So far this year, nine issuers worldwide (six based in the United States) have defaulted on a total of $2.1 billion of bonds, including five defaults in February on a total of $1.2 billion. R.J. Tower Corp. was responsible for the largest default last month, when its $453 million of bond was affected by the company’s Chapter 11 filing.

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