Defaults May Beat Great Depression, Junk Bonds Say (Update1)

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Defaults May Beat Great Depression, Junk Bonds Say (Update1)
By Bryan Keogh

Dec. 3 (Bloomberg) -- Yields on speculative-grade bonds imply a U.S. default rate of 21 percent, higher than the record set during the Great Depression in 1933, according to John Lonski, chief economist at Moody’s Investors Service.

The extra yield investors demand to own U.S. high-yield bonds was 19.19 percentage points on Dec. 1, according to Moody’s. Assuming a 20 percent recovery rate, the spread implies a default rate of 20.9 percent, Lonski said yesterday in a market commentary. That compares with a rate of 11 percent in January 2001, 12.1 percent in June 1991 and 15.4 percent in 1933.

Defaults and bankruptcies are accelerating as financing options for high-yield companies dwindle amid the longest U.S. economic recession in at least 26 years. The U.S. default rate rose to 3.3 percent in October, according to Moody’s, which forecasts the rate to increase to 4.9 percent in December and 11.2 percent by November 2009.

“The default rate is going to start rising quickly, soon enough it’s going to be breaking above 10 percent,” Lonski said in an interview. “Lack of access to financial capital is a very big problem for high-yield bonds.”

Hawaiian Telcom Communications Inc., a provider of local and long-distance telephone service, and Pilgrim’s Pride Corp., the largest U.S. chicken producer, sought bankruptcy protection on Dec. 1, as they struggled with too much debt taken on before the credit crisis.

Trump Entertainment

Trump Entertainment Resorts Inc., the casino company founded by Donald Trump, had its ratings cut by Moody’s on Dec. 1 after announcing last week it would forgo a $53 million interest payment to conserve cash.

Moody’s lowered its probability of default rating to Ca from Caa2 and its rating on the company’s senior secured notes due 2015 to Ca from Caa2, with a negative outlook, suggesting the company is more likely to default.
The National Bureau of Economic Research, the panel that dates American business expansion, on Dec. 1 confirmed that the U.S. economy has been in a recession for 12 months, making it the longest since 1982. The economy shrank at a 0.5 percent pace in the third quarter after expanding 2.8 percent in the previous three months. Economists expect a 2.2 percent contraction in gross domestic product for the fourth quarter, the average estimate from a Bloomberg survey.

Three companies have sold $2.7 billion of high-yield bonds this quarter, compared with $30 billion in the same period a year ago, according to data compiled by Bloomberg. Leveraged loans arranged this year total $301 billion, down more than a third from last year, Bloomberg data show.

“There’s a lot of forced selling of high-yield bonds by hedge funds owing to the need to de-lever as well as by mutual funds in response to redemptions,” Lonski said. “You’re looking at a market where the sellers well outnumber the buyers and the reluctance on the part of buyers makes sense if only because a bottom for economic activity is not yet in sight.”

High-yield, high-risk bonds are rated below Baa3 by Moody’s and BBB- by Standard & Poor’s.

To contact the reporter on this story: Bryan Keogh in New York at bkeogh4@bloomberg.net
Last Updated: December 3, 2008 13:13 EST

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