Bond Prices Imply Corporate Defaults at 2X Rate Forecast by Agencies

In an amusing bit of irony, Standard & Poors chief, in an interview, acknowledged that the bond markets are anticipating that corporate defaults will run at twice the rate foreseen by the rating agencies.

Recall that roughly half the big business debt outstanding is junk, and nearly all of that was issued in connection with LBOs.

The credit markets for some time have operated on the assumption that the financial system is under severe stress (which is confirmed almost daily in the press) and recession, likely a deep one, is in the offing.

Even if that view seems a bit dour, would you side with the rating agencies given their track record?

From Bloomberg:

Investors are pricing in defaults on corporate bonds twice as high as projected by rating companies, said Deven Sharma, Standard & Poor’s president.

The rating assessor said on March 31 the default rate for non-investment grade U.S. corporate bonds may rise to as much as 5.7 percent and at least 3.4 percent by February next year, as companies are hurt by rising funding costs and a slowing economy. The rate was 1.09 percent in January.

“The markets are pricing in a default rate of nine or 10 percent for high-yield corporate debt, which is a lot higher than we’re forecasting,” Sharma said in an interview with Bloomberg TV. “There is a recession and the recovery will be somewhat slower than we anticipated.”

The number of companies at risk of having their credit ratings downgraded rose by three to a record 703 in March amid a slowdown in housing and consumer spending that has pushed the economy closer to recession, S&P said on April 1. The number of potential downgrades is 90 more than reported a year ago and 68 more than the 2007 average.

Almost 76 percent of negative ratings changes have been among high-yield, high-risk companies, the rating assessor said…

“There is a fundamental change of behavior by consumers,” he said. “For many years, going back to the Great Depression, consumers always first paid their mortgage and if they default, they would default on their credit cards. For the first time, in 2005, we started to see the line being crossed, where consumers are willing to walk away from their mortgages.”

New home foreclosures in the U.S. rose to a record high in the fourth quarter as borrowers with adjustable-rate loans walked away from properties before their payments increased, the Mortgage Bankers Association said in a March 6 report. Late payments, or delinquencies, were the highest in 23 years, the bankers’ group said.

Um, doesn’t it occur to her that the change in consumer behavior might have been triggered by the new bankruptcy law? If you are above median income in your state (meaning ineligible for Chapter 7), it is easier to walk from your mortgage than your credit card debt. Another example of unintended consequences…

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  1. Anonymous

    Bernanke: Bear Stearns Wasn’t a Bailout

    By MARTIN CRUTSINGER – 6 hours ago

    WASHINGTON (AP) — The Federal Reserve’s unprecedented actions to prevent the collapse of Bear Stearns were taken to preserve the “integrity and viability of the American financial system” and did not represent any kind of bailout, Fed Chairman Ben Bernanke said Wednesday.

    Bernanke told a congressional panel that the Fed and other government agencies were informed on March 13 that without help Bear Stearns Cos. would have to file for bankruptcy the next day, forcing the central bank to make the difficult choice of deciding whether to allow the nation’s fifth largest investment bank to collapse or provide assistance.




  2. foesskewered

    In some ironic fashion, the banks and specialist lenders who created an environment for disaster are being left with the mess; consider the all too familiar scenario, John Deadbeat buys a house he cannot afford thanks to the loan from bankofs, when resets or the prospect of negative equity arises, he walks away from the mortgage; the bankofs can neither sell (risk of fire sales), nor can they realistically expect more from John Deadbeat. If that banksofs had securitized that mortgage and sold on, it only means some other financial institution is left with the mess. It would seem the little man has gotten away from it, but if you think the Martin Wolf scenario plays out, he’s gonna be hit with the bill maybe in the public indebtedness route which has implications on the $. The result is balancing off 3 years boomtime against a bill that may take years to pay off collectively and there are people fighting to be president?!

  3. Anonymous

    Nixon was a choir boy!

    JP Morgan is not required to obtain the Fed’s prior approval to acquire Bear Stearns Cos., the Fed said in a brief statement.

    Bears Stearns Bank & Trust operates in New Jersey and is the 45th-largest bank in the state, controlling deposits of approximately $398 million, the Fed said. Upon completion of this acquisition, JP Morgan would remain the country’s third-largest bank, the Fed said.

    “Based on all the facts and circumstances, the board has determined that an emergency exists requiring expeditious action on the proposal,” according to the Fed’s order clearing the bank purchase.

  4. Anonymous

    This somehow seems related:

    April 2 (Bloomberg) — Moody’s Investors Service is the least accurate assessor of the risks of subprime-mortgage securities among the three largest credit-rating companies, while Fitch Ratings is the best, according to UBS AG.

    Moody’s assigns Caa2 or lower ratings to just 12 percent of the 292 bonds underlying benchmark Markit ABX indexes that UBS analysts expect to default. Both Fitch and Standard & Poor’s tag 57 percent of the bonds with equivalent rankings, according to a report from the New York-based analysts yesterday. A rating of Caa2 or CCC is eight levels below investment grade.

    “Moody’s trails badly,” UBS analysts including Laurie Goodman and Thomas Zimmerman wrote.

    Ratings firms have been pilloried by lawmakers and investors for failing to foresee a record surge in U.S. foreclosure rates and then being slow to downgrade debt tied to homeowners with poor credit, enabling looser lending ahead of the crash and costing bondholders. The rating services are based in New York.

    Fitch was rated the most accurate also because it doesn’t have AAA ratings on any securities tracked by ABX indexes that UBS expects to default, while Moody’s has 35 ranked the equivalent Aaa and S&P has 24 with top ratings, the report said. Fitch also rated the fewest ABX subprime bonds — only 200 of the 400 rated by Moody’s and S&P — meaning it was the “most conservative” when assessing new deals in 2005, 2006, and 2007.

    “Fitch has been the fastest of the rating agencies to recognize and correct its subprime mistakes,” the UBS analysts wrote.

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