Glut of Junk Bonds Seen Boosting Overall Bond Default Rate

Junk bonds now account for half of all corporate bonds, likely resulting in an escalating overall default rate, according to Standard & Poor’s. In a Credit Trends report, S &P said 50.41% of firms rated speculative grade at the end of the first quarter of 2008, 3% higher than during the comparable period in 2006 and 12% higher than a decade ago.

An increase in both defaults and downgrades and a drop of newly rated entities have affected the ratings distribution during the last quarter, S&P said. “Indeed, the flow of speculative-grade new entrants has been primarily responsible for the downward shift in the ratings distribution over the past few years. With lending conditions tight, however, the impact on the aggregate ratings distribution from newly rated speculative-grade entities has been muted.”

Despite some encouraging news on the earnings front in the first quarter, S&P says indicators of credit quality are negative:

Indeed, negative bias (the percentage of firms with a negative outlook or with ratings on CreditWatch with negative implications) is currently at 29%, and net negative bias (the difference between negative bias and positive bias) is at 17%, both much higher than the long-term averages of 20% and 3%, respectively.

“With profits still at risk within a weaker economic environment, we foresee a continued slide in credit quality, with downgrades outpacing upgrades in both investment grade and high yield, as well as an increase in the trailing-12 month speculative-grade default rate to 4.7% by the end of the first quarter of 2009, from 1.4% at the end of first quarter of 2008.”

The first quarter was the slowest for newly rated issuers since 1991, S&P said. Only the financial, utility, and real estate sectors remain predominantly investment grade. The media and leisure sector has the highest percentage of firms in speculative-grade territory, with 86%, followed by the health care (75%), automotive and capital goods (74%), and telecommunications (73%) sectors.

Further details are available in the S&P report U.S. Ratings Distribution: Glut Of Low-Rated Issuers Could Mean Escalating Default Rate.