The market for debt securities from issuers already in, or heading for, default has virtually stalled. And issuance may become even scarcer.
The market for debt securities from issuers already in, or heading for, default has virtually stalled. And issuance may become even scarcer.
“Non-investment-grade product froze up about a month ago,” said Ron Greenspan, senior managing director at FTI Consulting Inc., a Baltimore-based adviser to distressed companies and their creditors. “The market hasn't returned to normal.”
As of mid-September, there hadn't been a single new high-yield-bond issue for six weeks, according to Standard & Poor's Corp. of New York.
There is an overall feeling that risk has been underpriced, which is affecting almost all higher-risk products, Mr. Greenspan said. People are unsure about the values they should be putting on the issues, so they aren't making them at all, he said.
The biggest question concerns how long this state of affairs will last, Mr. Greenspan said. If the market doesn't become more liquid in about 90 days, he believes, a longer-term realignment may become likely.
Meanwhile, hedge funds are seeing opportunities amid the rubble.
Last week, Los Angeles-based hedge fund Dalton Investments LLC announced that it plans to buy defaulted loans from mortgage servicing companies at significant discounts and restructure them. Dalton said it will seek affordable monthly payments for homeowners and real-estate-based investments for Dalton investors.
“The subprime market is just beginning to unwind, and we expect defaults and foreclosures to skyrocket over the next six to 12 months,” chief executive Steven Persky said in announcing Dalton's new strategy.
Defaults in other industries also appear to be on the rise.
According to a Sept. 25 report by Standard & Poor's, the number of companies with issues trading at distressed levels was up for the first half of the month. This could herald more defaults if there is a market disruption, the New York-based rating agency said. Historically, a peak in the distress ratio, or the proportion of issuers in trouble to all issuers, precedes a peak in default rates by nine months.
The distress ratio rose to 2.9% in August and to 3.2% in September, after five consecutive months at less than 1%, the report said.
“The gauge to it will be general economic conditions,” said Diane Vazza, managing director of global fixed income research for Standard & Poor's. If growth in U.S. gross domestic product falls, speculative-grade companies will be the hardest hit, she said.
Standard & Poor's recently boosted its estimate of the likelihood of a U.S. recession to 40% from 30%, she said. The industries currently showing the greatest distress rates are the media and entertainment sector, consumer products, forest products and building materials, and the automotive industry, according to the company.
Even some of the private-equity deals completed in recent years could result in additional defaults and bankruptcies if there is a downturn, said George Putnam, chairman of Boston-based New Generation Research Inc., which maintains a website of bankruptcy information.
A softening economy or a dip in consumer spending will hurt corporate financial results in a variety of industries, bringing more issues into distress because they won't be able to service their debt, he said.
Despite a calming of domestic stock markets since the Federal Reserve announced a half-point cut of the federal funds rate last month, Mr. Putnam said he expects to see more defaults and bankruptcies going forward.
“Overall, there is a heightened awareness of the risk of some high-yield and leveraged-loan issues,” he said. Based on an increase in the spread on speculative-grade bonds, investors are beginning to require higher returns for the risk they take on with distressed debt investments, he said.
Scott Coleman, an adviser with KRD Financial LLC in Schaumburg, Ill., has clients invested in distressed-fixed-income investments, and he's wary.
“The subprime-mortgage meltdown has made me more aware of the volatility that can happen in some of these distressed areas,” said Mr. Coleman, whose firm has $65 million in assets under management.
Even in investments that have no direct relationship to the subprime market, the spillover to all risky investments caused greater loss than might have been expected based on historical risk measurements, he said.
While the Federal Reserve rate cut has lessened investor worries, Mr. Coleman said, there is still a lot of concern that the full effect of the subprime mortgage losses hasn't yet hit. “I'm taking the cautious view about anything that is distressed,” he said.
