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« Goldman Admits It Goofed | Main | Have Lunch With Warren Buffett » June 24, 2008 Junk Default Recoveries Maybe Lower Than UsualI’ve been surprised by the wide yield spread between low-risk bonds and high-risk bonds. Just look at the downward drift of Vanguard’s High-Yield Corporate Bond Fund (VWEHX).
I called Vanguard and the fund pays a dividend yield of 8.61%. Wow, that creams just about anything else you can find today. Of course, they’re called junk for a reason. High-yield bonds have a greater risk of defaulting than investment grade debt. In today’s Wall Street Journal, Liz Rappaport says that if defaults do happen, the amount recovered could be less than it has been in the past. A report to be published Tuesday by Moody's Investors Service argues that the explosion of loans issued by junk-rated companies in the past few years means that if they default, the recoveries on these loans might be less than in the past. Here’s the money quote: Now, Moody's expects loan investors to fare almost as badly as investors in riskier junk bonds have done in previous busts. "It doesn't matter what you call something," says Kenneth Emery, author of the report. "What matters is where you sit in the liability structure." Historically, it’s fairly rare for a bond, even a junk bond, to default. The long-term rate for junk is about 2.6%, but for investment grade bonds, the default rate is just 0.1%. However, defaults can often spike dramatically higher. There have been times when the junk default rate has hit 15%, while it’s never gone above 1.6% for the highest-grade bonds. Reuters reports today: The U.S. default rate on junk bonds, high-yield debt that is below investment grade, rose to 1.89 percent in May, a 26-month high, from 1.64 percent in April. The rate is expected to rise to 4.7 percent within a year and there is a 20 percent chance it could go as high as 8.5 percent, S&P said. Posted by edelfenbein at June 24, 2008 10:31 AM |
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