Corporate Bond Market Says A Tsunami of Debt Default is Coming

Wall Street is throwing an equity party and painting the tape for the end of month bonus calculations.

But the corporate bond markets are signalling serious economic trouble dead ahead, NOT behind us.

Brace for disillusion.


Crumbling bond market sounds distress alarm
Tue Jul 29, 2008 7:25am EDT
By Walden Siew and Dena Aubin

NEW YORK (Reuters) - Corporate bond investors are bracing for growing defaults and record company bankruptcies starting in 2009 as the volume of distressed debt climbs past $184 billion, an all-time high.

More corporate debt is now trading at distressed levels than in 2002, when there was $165 billion of distressed corporate debt following the last bankruptcy boom, according to Moody's Investors Service data.

Nearly one in three junk bonds trade at levels known as "distressed," suggesting a serious risk of default. Even higher-rated corporate bonds have sunk to distressed levels in near-record volumes.

Automakers General Motors Corp and Ford Motor Co lost their investment grade status in 2005 and their bonds have since plummeted to distressed credit levels.

Now bonds of financial firms such as CIT Group Inc, National City Corp, and bond insurers like MBIA Inc are trading as though investors expect them to follow that ignominious path.

"It's the fast deterioration of some of the higher-rated credits that is most alarming," said Jason Brady, a managing director at Thornburg Investment Management. "From a dollar standpoint, we're going to see a record wave of defaults and bankruptcies."

Spokespersons at CIT and National City didn't immediately return phone calls seeking comment about how their debt is trading. MBIA's spokeswoman cited the company's policy of not commenting on its bond market performance.

The total amount of high-yield debt trading at distressed levels is now $147 billion, while investment-grade distressed debt is about $37 billion, according to Moody's credit strategy group.

"The market is pricing in pretty ugly bankruptcy scenarios," said Brady from his Santa Fe, New Mexico, office, where the firm oversees $4 billion in fixed-income assets. "The dramatic bank deterioration is coinciding with the overall level of distress."

A slumping economy, high oil prices and tighter credit conditions are putting a greater squeeze on corporations and impacting their ability to manage and pay off their debt.

Credit crisis fears, especially in the financial sector, have pushed yields on several companies into distressed territory recently, though rating agencies still assign them low default risk.

High-grade companies trading at distressed levels in recent days include Washington Mutual Inc, CIT and Ambac Financial Group, according to MarketAxess.

Ambac's spokeswoman declined to comment, while Washington Mutual didn't immediately return a call.

In all, about 7.5 percent of high-yield and investment-grade debt combined is distressed, the same level seen during the credit downturn of 2000 to 2002, when bankruptcies soared, according to data from research firm Leverage World.

Public company bankruptcy filings climbed to 179 in 2000 and rose to a record 263 in 2001, according to bankruptcy court records.

"Investment-grade bond distress is a new feature of this cycle," according to analyst Christopher Garman, adding, "The largest corporate bankruptcies on record often follow this level of distress."

Some 27.2 percent of high-yield bonds by par value are distressed, or trade at yields of at least 1,000 basis points more than U.S. Treasuries, Garman wrote for Leverage World in a report titled "MegaDefault."

The 7.5 percent distress level points to nearly $97 billion of defaults through 2009, said Garman, a former head of high-yield strategy at Merrill Lynch.

For investment-grade bonds, the distressed level has climbed to 1.8 percent, shy of an all-time high of 2.4 percent. If all the high-grade distressed debt were downgraded, it would increase the volume of high-yield debt by 6 percent.

Both Standard & Poor's and Moody's Investors Service have noticed a sharp increase in junk bonds and credit default swap contracts trading at distressed levels as well.

The overall number of U.S. high-yield bonds trading at distressed levels has soared to about 27 percent, versus 17 percent in April and just 2 percent last year, according to Moody's research group.

More than 20 junk-rated borrowers have credit default swaps trading wider than 1,000 basis points, which implies a 58 percent chance of default over the next five years, according to Credit Derivatives Research.

Much of the distressed debt is in the auto sector, but high-yield opportunities may be growing in the financial sector, said Joe Robison, director of credit research at Allegiant Asset Management.

"As autos go, so does the high-yield market these days," Robison said. "Our area of emphasis is watching the financial companies. We're definitely going to see some financial names go from investment-grade to junk over the next years, and that's where we see opportunities."