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Business News/ Opinion / Online-views/  Junk bond distress levels surge, signalling defaults
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Junk bond distress levels surge, signalling defaults

Junk bond distress levels surge, signalling defaults

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London: More than 30% of European high-risk, high-yield bonds are trading at distressed levels, the most in five years, stoking speculation defaults will rise.

Investors demand an extra yield over government debt of more than 10 percentage points to hold 53 of the 169 bonds in Merrill Lynch and Co.’s Euro High Yield Constrained Index. That’s the biggest proportion of distressed debt since March 2003, in the aftermath of the 11 September terror attacks and the dot-com crisis.

“Typically, those levels of distress would indicate that defaults are going to rise," said Karl Bergqwist, who manages the equivalent of about $500 million (Rs2,250 crore) in high-yield debt at Gartmore Investment Management in London. “We think there’s much worse to come. Spreads could go a lot wider and defaults are undoubtedly going to go up."

Defaults on European speculative-grade corporate bonds will climb to 2.3% in a year, from 0.7% now, near a record low, Moody’s Investors Service said in an 8 September report. Worldwide defaults will surge to 7.4%, from 2.7%.

Spreads on high-yield debt have widened as investors, fleeing the fallout from the collapse of the US subprime mortgage market, shun all but the safest bonds and as banks tighten lending standards. The average yield in the Merrill High Yield index, an indication of the absolute cost of debt to companies, is now 12.3%, twice the level of last March.

Europe’s primary high-yield bond market has been effectively closed since July 2007, data compiled by Bloomberg show. Last year, companies borrowed the equivalent of $32.1 billion using such securities, with all but $5 billion in the first half. Now, amid spiralling money market rates, investors are wary of speculative borrowers. High-yield, or junk, bonds are those rated below Baa3 by Moody’s or BBB- by Standard and Poor’s.

“If companies find it difficult to raise money in the bond market at the same time as banks are tightening lending, then the probability of default increases," said Guy Stear, a strategist at Societe Generale SA in Paris. “That’s the case even if the fundamental business is sound."

The firm expects makers of durable consumer goods such as furniture, floor coverings and fridges to show the highest default rate in Europe. The companies with the largest share of bonds in euros at distressed levels are General Motors Corp. and its finance unit, General Motors Acceptance Corp., according to Bloomberg data. In Europe, six bonds sold by chemicals companies and nine issues from financial firms have spreads above 1,000 basis points more than government debt.

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Published: 11 Sep 2008, 10:47 PM IST
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