Junk Bonds Are Living Up To Their Name
DEFAULTS on speculative-grade corporate bonds - ``junk bonds'' - are on the rise once again, reflecting the strain of the recession on many over-leveraged corporations. What's worrying some bond experts is that defaults are coming far faster than expected - and surpassing default rates for the recession of 1981-82. ``We're having to reassess all our estimates on defaults,'' says Richard Lehmann, president of the Bond Investors Association (BIA), and editor of the Defaulted Bonds Newsletter, a monthly guide published in Miami Lakes, Fla.
Last fall, the BIA expected that corporate-bond defaults would reach about $25 billion for 1991, after defaults of $4.6 billion in 1988, $11.8 billion in 1989, and $26.4 billion in 1990. But the organization has had to substantially boost estimates for this year. He now anticipates that defaults will reach $35 billion this year, and perhaps as high as $50 billion.
Moreover, he predicts that roughly half of all junk bonds issued between 1985 and 1989 - the period when junk bonds were widely used to finance leveraged takeovers and other speculative Wall Street endeavors - will go into default. That 50 percent rate would be well above the more typical 38 percent default rate for junk bonds in the past. All told, some $100 billion in bonds will need to be financially restructured during the next two to three years, Lehmann says.
Junk bonds are high-yield but highly risky bonds issued by companies that for one reason or other could not get a corporate-grade rating. Estimates as to how many junk bonds are outstanding vary. The traditional number, popularized by the former Wall Street firm of Drexel Burnham Lambert (which was a major underwriter of junk bonds until its eventual collapse) was about $200 billion.
``But Drexel went out of its way to overlook many bonds with high default rates,'' Lehmann says. He reckons that there are $300 billion in junk bonds outstanding, some of which started out as corporate-grade issues (BBB or better), and were subsequently downgraded.
Whatever the actual number of junk bonds outstanding, there is little doubt about the rush towards default. During the first quarter of 1991, a total of 32 companies defaulted on junk issues worth $8.2 billion, according Jerome Fons, an official of Moody's Investors Service. That compares with defaults by 19 companies on bonds worth $5.7 billion during the first quarter of 1990.
Looked at over the course of the past 12 months, the default rate is not that bad, says Fons. But the default rate began to rise late in the year. For the second quarter of 1990, bonds worth $4.6 billion were in default; for the third quarter, $4.6 billion; for the fourth quarter, $7.2 billion.
MOODY'S default numbers are not the same as those of the BIA, since Moody's monitors a somewhat different universe of junk bonds than BIA.
But using either set of statistics, defaults were up substantially for the first quarter of this year. BIA finds 27 companies defaulting on $11 billion in bonds for the first quarter of 1991, compared to defaults by 19 issuers on $6 billion worth of bonds in the first quarter of 1990. BIA also finds that the current default rate is running at a 16 percent annual rate.
Moody's notes that there were some 91 downgradings of corporate bonds during the first quarter of 1991, versus just 24 upgrades.
Despite an increase in junk-bond prices, Fons does not yet see a revival for new issues of high-risk bonds. He says a number of factors could prevent a recovery, including the inability of the beleaguered savings and loan industry to buy new speculative issues. S&Ls had been one of the mainstays of junk bonds.
Similarly, banks are more ``capital-constrained'' in buying junk bonds than was true in recent years, while insurance companies (which hold a lot of junk issues) are coming under mounting political pressures to stay away from the speculative bond market.
Still, Fons believes that as the economy improves, junk bonds will again be attractive.
The derailing of the junk bond market has meant that smaller companies are finding it very difficult to attract new financing, Lehmann says.