Vaulting to Defaults

Despite the hot economy, defaults are increasing to a surprising level.


A hot economy and a high bond default rate? Defaults are increasing to a surprising level, spurred by an optimistic junk-bond frenzy that rivals the one at the end of the last decade.

Moody's Investor's Service estimates that $157 billion in high-yield, or junk, bonds were issued in 1998, almost 16 times the amount issued in 1991. Meanwhile, defaults on high- yield bonds posted their fastest quarterly rise since World War II, during the latest fiscal frame. And, according to Moody's, investors can expect higher corporate bond default rates for the next seven months.

"The size of the speculative-grade market has been growing because the capital markets have been willing to take on more risk and to take away potential bank customers," explains Sean Keenan, a senior analyst with Moody's. "These low-rated companies would have existed without this financing; they simply would not have issued bonds and would have had to stick with bank financing to fund their growth." Also, there have been transactions done with investors paying 11, 12, 14 times the value of a company "that doesn't have the growth prospects or sustainable advantage that would justify such a multiple," says Scott Sperling, managing director of Thomas H. Lee Co., in Boston. "Those deals can run into trouble rather quickly." How quickly can be found in Moody's figures showing that the period from the time high-yield debt is issued to the time it becomes "distressed" has dropped from three years in 1996-97 to two years in 1998-99.

As the size of the speculative market increases, one would expect the number of defaults to increase, Keenan explains. But that doesn't explain why the default rate--the number of defaults divided by the number of deals--is rising. What's happened is that the number of deals since the fourth quarter of last year has slacked off the pace of the two previous years, while the defaults from those deals are happening faster.


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