After several years of sound performance, the junk bond market is starting to see defaults creeping in.
According to Moody's Investors Service, the 12-month trailing default rate for junk bonds could go as high as 2.5%, or $10 billion, this year. In 1997 the rate reached 1.82%, up from 1.64% the year before, Moody's said.
In recent months, issues from Bruno's Inc. and APS Holding Corp. have defaulted, causing some observers to wonder whether the credit environment has changed.
The Asian financial crisis is another factor contributing to concerns about the future of the market.
"While the degree of escalation observed to date in defaults is not alarming, the pickup does reinforce our impression that the credit environment is changing for the worse," Martin Fridson, chief high-yield strategist at Merrill Lynch & Co., wrote in a recent report.
"At this late stage of the expansion, the bottom-tier credits are already looking frayed," he added.
Overall, the junk bond market is in good shape, experts said. The increase in defaulting debt is simply a result of the heavy volume of new issues, they said.
"Whenever you have a large new-issue calendar, after about 18 months you're going to have your problems," said Richard Miller, head of high- yield research at BancBoston Securities Inc.
"I'm sure you'll see a round of workouts coming," Mr. Miller said, "but that's just the market."
Barring some additional source of instability or weakness, the junk bond default rate should remain below its post-1970 average of 3.38%, said Sean Keenan, a vice president at Moody's.
The conditions that keep default rates low-low interest rates, enormous liquidity in the stock and bond markets, and a continuously expanding economy-seem to be staying in place, Mr. Keenan said.
Overall, the corporate bond market, including investment-grade issues, had 64 defaults in 1997, totaling $8.5 billion. That was up from 26 defaults, totaling $5 billion, in 1996.
Some say that the immense breadth and depth of today's high-yield market is a positive. There are more junk bond issuers, underwriters, and investors than ever before.
"It's a bigger market, which is a good thing," Mr. Keenan said. "It's a good thing when the capital markets can provide capital to risky entities without jeopardizing the whole market."
Despite intense competition between Wall Street firms and commercial banks' high-yield shops, observers said that both are doing their part to keep standards high.
They "recognize the importance of maintaining strict underwriting standards and a high level of quality," said John Popp, a managing director at First Dominion Capital. "Not only to make money for their issuers, but they've got their clients on the buy side to think about too."
"That said, given the increased supply of capital in the debt markets, issuers will try to push a little bit more in terms of leverage," Mr. Popp added.
The worry is that investors have been bombarded by new issues for so long that they have not been able to give the necessary attention to each issue.
"There's been a lot of money; the high-yield market is awash in liquidity; and that's made it easier for companies that may not have been able to get funds in a less liquid time to do so," said Robert Kern, a portfolio manager at Safeco Asset Management, Seattle. "That's a good reason to be cautious."
