The Coming Junk Bond Wipeout

While the government is in a frenzy trying to convince banks to lend more money, borrowers are heading into a deep recession. This seems like a recipe for another financial crisis.

Fitch’s analysis of the situation is grim. Investors in high yield bonds are going to get wiped out, and the worst of the defaults will strike over the next two years. Is it really a good idea for the government to pressure banks to lend more heading into this kind of economic environment? Wasn’t government pressure to lend to shaky borrowers what got us in this mess to begin with?

From Reuters:

The coming wave of U.S. high-yield corporate bond defaults may be the worst ever and impact more industry sectors than the downturn of 2001-2002, Fitch Ratings said Thursday.

A record 24 per cent of the U.S. high-yield market is currently rated “CCC”, or eight grades into speculative, or ‘junk’, status, placing a full $188 billion of debt at risk of default, the agency said in a report.

“Economic weakness will continue to add to the pool of high risk borrowers,” said Mariarosa Verde, managing director of Fitch Credit Market Research.

“Add tight credit to the mix and the result will either be a concentrated surge in defaults over the next two years or a protracted period of above-average annual default rates.”

Low corporate default rates that acted as a support for the high-yield sector have fallen apart at an alarming rate in 2008, and the recent turmoil in financial markets has added to the gloom, said the report.

Default rates typically surge a year after meaningful contraction in corporate profit growth. That trend emerged in 2007 and has accelerated into 2008.

High-yield defaults have already started to rise but the worst impact will be felt in 2009 and 2010. The trend will be exacerbated by tight borrowing conditions, said Fitch.

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