Junk Bonds Getting Junkier

The number of issuers in the lowest liquidity category, and the percentage of those receiving downgraded ratings, reach record levels in September.

Credit quality continues to wither in the junk bond market. Among 10 new issuers assigned junk ratings in September, there were seven downgrades and just two upgrades, according to Moody’s Investors Service.

Three of the companies were downgraded to the lowest of four credit levels, SGL-4, while none was upgraded from that level. Altogether during the third quarter there were nine downgrades to SGL-4, and only one issuer was upgraded out of that category. As a result, the total number of issuers with the weak liquidity rating increased to 28 in September from 26 in August, matching the record number reached most recently in January 2007. There were also 28 issuers with an SGL-4 liquidity rating at the end three 2006 months: March, August, and November.

A 90 percent downgrade ratio among issuers in the weakest rating category was the worst since the universe of Moody’s-rated SGL issuers reached a meaningful level, the debt-rating company noted in its Speculative Grade Liquidity Monthly Monitor. The total SGL population first exceeded 100 in September 2003.

The quarterly number of downgrades to SGL-4 peaked at 11 in the third quarter of 2005 and the first quarter of 2006. However, the downgrade ratios were smaller then, at 78.6 percent and 64.7 percent, respectively.

According to Moody’s, as of September 28, 2007, there were 448 active SGL ratings with total rated debt of about $1.015 billion. The top 10 SGL issuers accounted for one-quarter of the total.

The 12-month SGL-4 default rate climbed to 20 percent in September from 14.3 percent in August. The rate was just 5.3 percent in June but now is at its highest level since the 25 percent recorded in May 2006, Moody’s said. The SGL-4 default rate is now a shade above its 19.9 percent historical average, dating back to October 2002. However, it remains below the 50 percent peak of September 2005.

It’s little surprise, then, that Moody’s projects the U.S. speculative-grade default rate will climb to 3.9 percent by September 2008 from the current 1.4 percent. “A backdrop of increasing risk aversion coupled with weakening intrinsic liquidity among low-rated issuers creates the potential for more defaults,” Moody’s explained.

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