| Financial Week - June 25, 2008 by Marine Cole
The quality of high-yield bonds continues to deteriorate, but the weakest borrowers are finding that they can no longer access the debt markets.
Consider this: In 2001, 61% of companies rated speculative grade (below BBB- according to Standard & Poor’s and Fitch Ratings and below Baa3 according to Moody’s Investors Service) were rated in the top tier, meaning above BB- or Ba3. That ratio declined to 24% in 2007.
The percentage of stronger high-yield borrowers actually increased to 44% through the first five months of this year. But that sudden jump does not signal an improvement in the creditworthiness of speculative-grade borrowers. In fact, just the opposite is true.
“It is not the case that companies are generally improving their credit characteristics, but rather that weaker borrowers are getting shut out,” said Martin Fridson, chief executive of Fridson Investment Advisors.
“Investors have not been receptive to the ultra-risky issuers that were able to tap the market during the ebullient period in the middle of this decade,” he said. “The heightened cautiousness of investors is likely to persist for the rest of the year.”
That confirms analysts’ comments that the default rate is poised to worsen.
As of the end of May, the default rate stood at 1.89%, according to S&P, which projects that the rate will increase to 4.7% by the first quarter of 2009.
Credit quality continues to deteriorate rapidly, Diane Vazza, an S&P managing director, wrote in a report published Monday. There were 118 high-yield downgrades between March and May, versus 88 from December through February.
“Our projection for increased defaults reflects the challenging economic conditions, weaker and more variable earnings prospects, and borrowing constraints in capital markets,” according to Ms. Vazza.
At the same time, supply has been subdued this year. About $25 billion of junk-rated debt was sold through June 20, down from $100 billion in the first half of 2007 and $65 billion in the first half of 2006.
Total high-yield issuance might end 2008 just under $50 billion.
“The primary high-yield market is open for small and midsized issuers of stronger credits, but very risky, highly leveraged deals are unlikely to get much traction,” Ms. Vazza wrote.
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