Thursday October 12 4:00 PM ET Junk Bond Defaults Seen Surging

By Jonathan Stempel

NEW YORK (Reuters) - The rate of defaults among ''speculative-grade,'' or junk-rated, issuers fell in the third quarter, but is likely to rise nearly 64 percent in the next year, Moody's Investors Service said in a new report.

The credit rating agency said default rate fell to 5.13 percent for the 12 months ending in September, from 5.51 percent for the 12 months ending in June. Twenty companies defaulted on $8.4 billion of debt in the third quarter, Moody's said.

Despite the decline, Moody's warned the rate is likely to rise to 8.4 percent by the end of September 2001.

If, however, the third quarter proves not to be a ''statistical fluke,'' then the rate could be ``virtually unchanged'' a year from now, wrote David Hamilton, a Moody's risk management analyst.

Moody's said that unlike in 1999 the defaults were spread over many sectors, rather than concentrated in a few, suggesting credit weakness in many areas.

Year-to-date, it said, there have been 82 defaults affecting $22.9 billion of long-term public debt.

Among companies defaulting in the third quarter were the No. 3 U.S. movie theater operator, Columbus, Ga.-based Carmike Cinemas Inc.(NYSE:CKE - news), and the No. 1 bowling alley operator, Richmond, Va.-based AMF Bowling Worldwide Inc. (NYSE:PIN - news)

Debt issued by junk-rated companies, which carry ratings of ''Ba1'' or lower from Moody's, yields more than higher-quality debt to compensate investors for its extra risk.

The Moody's report comes at a time when lenders, having been burned from freely extending credit from 1996 through the middle of 1998, have grown more unwilling to extend new credit or refinance existing credit to junk-rated companies. That has left many companies with nowhere to turn when they need cash.

That credit crunch is one reason corporate credit quality is in a steep fall.

In the third quarter, Moody's said, speculative grade companies suffered 75 rating downgrades affecting $44.3 billion of debt, while enjoying just 29 upgrades affecting $19.1 billion.

Not since 1989 has the ratio of debt downgraded to debt upgraded been higher, Moody's said.

Hamilton was not immediately available for further comment.

-- Carl Jenkins (Somewherepress@aol.com), October 12, 2000

Answers

Thursday October 12, 3:01 pm Eastern Time US corporate bonds are in bad shape, and getting worse By Jonathan Stempel

NEW YORK, Oct 12 (Reuters) - Corporate bonds can't seem to catch a break.

The bonds, touted for months by many experts as worth a look from investors because of their bargain-basement prices, now are only getting cheaper.

Not since the 1998 financial crisis following Russia's debt default, when investors shunned all but the safety of U.S. Treasury bonds, has the situation been this bad, experts said.

Prices on corporate bonds have fallen over the past week, pushing out the yield gap between the bonds and U.S. Treasuries by 0.1 to 0.2 percentage points.

And with corporate profits and credit quality declining, no turnaround appears on the horizon.

``The market is jumpy,'' said Steve Bohlin, who helps manage $1.8 billion of fixed income investments for Thornburg Investment Management Co. in Santa Fe, N.M. ``As we see weakness emerge, it makes people wary about their credit exposure.''

INTOLERANCE OF POOR EARNINGS

Corporate bonds yield more than super-safe Treasuries to compensate investors for extra risk. The difference in yield between the bonds and Treasuries is called a spread.

Since mid-September, investors have punished many of these bonds the way they traditionally punish stocks. Earnings shortfalls are a big reason for that.

In the last month, there has been a string of high-profile warnings of lower-than-expected profits from companies such as No. 1 home improvement retailer Home Depot Inc. (NYSE:HD - news), No. 1 phone equipment maker Lucent Technologies Inc. (NYSE:LU - news) and No. 2 cell phone maker Motorola Inc. (NYSE:MOT - news).

Warnings such as these have been blamed on a strong U.S. dollar and companies' inability to pass on high energy and other costs to consumers.

Bond investors are showing no patience for such warnings. And with the Federal Reserve having last week said inflation remains a risk to the U.S. economy, and that interest rate cuts aren't in the works, more disappointments could be on the way.

``There's a little bit more concern now that perhaps the Fed will not succeed in engineering the soft landing,'' said Martin Fridson, chief high-yield strategist at Merrill Lynch & Co.

New bond supply is also a concern. Bonds of telecommunications companies in particular have performed poorly under the weight of tens of billions of dollars of existing and anticipated supply.

Then there are credit ``bombs,'' such as building materials maker Owens Corning's (NYSE:OWC - news) stunning bankruptcy filing last week because of asbestos lawsuits, or persistent retail sales weakness such as that suffered by J.C. Penney Co. (NYSE:JCP - news).

On top of this, dealers have since the 1998 crisis committed progressively less capital to the market. That causes the liquidity of bonds in trouble to dry up.

``If you see any negative news from earnings headlines or credit bombs..., investors will punish spreads, and because the liquidity isn't in the system dealers aren't there to buy,'' said Stewart Morel, co-head of high-grade research at UBS Warburg LLC in Stamford, Conn.

JUNK BONDS LOOK WORSE

The problems aren't limited to high-quality bonds.

If anything, for junk bonds, where yields and risks are even higher, things are worse. After two years of near barely positive total returns, many experts thought junk bonds would recover this year. Indeed, the bonds have on occasion shown fleeting signs of life.

Yet, it is the only major bond asset class to post negative total returns this year, according to Merrill Lynch.

``One could look throughout the year and pick points in time when junk bonds looked historically cheap, but the market just keeps grinding lower,'' said Michael Guarnieri, managing director of high- yield research at Lehman Brothers Inc.

More than $4 billion of net outflows from junk bond mutual funds have sapped available cash. Credit quality is dropping, with downgrades affecting more than twice as much debt this year as last according to Moody's Investors Service. The default rate rivals that in the 1991 recession, and Moody's expects it to reach 8.4 percent by next September.

Rumours in the last week that three big investment banks suffered big losses trading junk bonds jangled investors' nerves. Small- capitalisation stocks, whose movements according to Fridson correlate highly with those of junk bonds, have been pummeled. And, Federal banking regulators said this week the amount of ``problem'' loans surged 70 percent from last year.

``For a number of reasons, not by any means irrational, investors are exacting a more severe penalty from companies that suddenly look weaker than they did,'' said Fridson.

That's unlikely to change, at least not this year, experts said. It's a time to be defensive, not aggressive, they said.

``The macro viewpoint has changed,'' said Bohlin. ``A year ago, when companies missed their earnings, investors would be hopeful they would make it up in the next quarter. Now, if you believe the economy is likely to deteriorate, it's not as easy to believe the next quarter will be better.''

http://biz.yahoo.com/rf/001012/n12452542.html

-- Carl Jenkins (Somewherepress@aol.com), October 12, 2000.