Wednesday, September 30, 2009

THE US CORPORATE BOND DEFAULT BUBBLE

THE NEXT BUBBLE TO BURST OUT
When every one is focusing on US economy coming out of recession and stabilizing another bubble is in the wings. The bubble this time is corporate defaults in Debt.
Global corporate defaults till now in 2009 is 215 issuers--nearly 4x the 59 defaults at this time in 2008, according to an article published today by Standard & Poor's. Defaulter was based in the U.S. bringing the default tallies by region to 155 issuers in the U.S., 13 in Europe, 34 in the emerging markets, and 13 in the other developed region (Australia, Canada, Japan, and New Zealand). Missed interest payments account for 74 defaults so far this year.
At the same time Bankruptcy filings have also surged to 54 issuers so far this year have filed for bankruptcy protection, which surpasses the full-year 2008 total of 49 bankruptcy-related defaults.
Most of the defaults are happening on speculative grading and expectations.
This one like in 2008. But this time the default is on Debt/bond defaults by corporate. This is the new bubble going to burst out any time soon.

The defaults mechanisms

Bonds are issued by corporations or a governmental body to provide cash flow. Then if the business fails, then the bond is worthless. When it comes to bonds and recessions. with less than investment grade bonds, recession increases the default risk increasing the possibility that the company won't pay the bonds as agreed. If the risk of default increases, investors will demand a higher return. Higher return means lower price of bonds. Recession or any sort of turmoil tends to mean that some corporations will see their credit ratings downgraded. When the rating agencies downgrade a company's bonds the yield gets reduced of that company bond. So while your particular bond might be expected to rise because of the interest rate effect, you can get sucker punched by a downgrade.

Defaults till now and the progress.
The prolonged U.S. recession, the speculative-grade default rate in the U.S. has reached double digits. The number of corporate defaults in 2009 continued the expansion seen at the end of 2008, with 18 more U.S. defaults in August, bringing the year-to-date total to 147. The number of U.S. companies that have defaulted on their debt this year rose to 12.2% in August, matching a peak last touched in 1991. If the U.S. unemployment rate were to increase substantially above 10% in the coming year, then default rates would likely be significantly higher.

The outlook remains dim for the weakest companies. We can't forget that more than 60% of all U.S. non financial corporate debt is speculative-grade, and 26.4% of companies in this category are rated B- or lower. Loan market volumes have typically constituted roughly 75% to 80% of speculative-grade borrowings in recent years. About 50% of defaults  have occurred in sectors like media, entertainment, automotive, chemicals and packaging industries.

More defaults will come from debt exchanges -- meaning a company agreed with its bondholders to exchange old debt for new debt and equity. the U.S. economy to bottom by the end of this year, corporate default pressures will remain as many companies continue to struggle to meet interest payments on heavy debt loads.

Expected Bursting time of the Bubble
The precipitous increase in defaults reflects a pronounced decline in economic fundamentals and earnings prospects of US companies. We will find the bubble burst out most probably in the 3rd quarter of 2009 and 1st quarter of 2010.

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