Defaults Pile Up
Don't be fooled: More companies are missing interest payments as the bond market strengthens.

Credit markets may look welcoming, but heavy debt burdens continue to sink companies. The rate at which U.S. corporate debt issuers missed interest payments rose to 10.2% in May from 9.3% in April, according to a report from rating agency Moody’s Investors Service on Thursday. The default rate was a mere 2.2% in May of last year.

Moody’s counted 23 defaults last month, usually an early step on a company’s path to bankruptcy. The list of companies known to have defaulted last month includes paper recyclerCaraustar Industries ( CSAR - news - people ), phone book publisher R.H. Donnelley ( RHD - news - people ), Inn of the Mountain Gods Resort and Casino and Lazy Days’ R.V. Center. Caraustar and R.H. Donnelley, which defaulted on $10 billion in debt, have filed for Chapter 11 bankruptcy.

Bond yields and the unemployment rate drive the default rate. With credit still tight compared with recent years and more people out of work, rating agencies say defaults will continue to climb, even after the economy hits bottom. Defaults, like unemployment figures, typically lag economic output. (See "Defaults Will Climb As Economy Improves.")

Moody’s forecasts the speculative-grade default rate to peak at 13.5% in November. The automotive sector will likely get hit hardest, pushing others into bankruptcy behind General Motors ( GMGMQ - news - people ) and Chrysler. Other industries expected to suffer: media, consumer products and retail.

It could be worse. Kenneth Emery, Moody’s director of research, noted that the expected default rate has dropped as investors have returned to buying high-yield bonds, pushing yields down. That makes debt less costly for companies looking to raise cash in the bond markets.

The U.S. High Yield Master II Index, a widely used measure of junk-bond performance, has gained 27.8% in the past three months. A typical junk bond pays 11 percentage points more in yield than similar Treasury notes.

On Monday, rating agency Standard & Poor’s released a report on default rates that had a bleaker outlook. S&P expects the default rate to rise to 14.3% -- a modern-day record -- by next April. Under a worst-case scenario, 18.5% of speculative-grade companies could default.