Junk Bond Default Rate Continues to Decline

High-risk bonds are getting less so: The annualized default rate on corporate junk bonds worldwide fell to 5.7% in September from 6% in August, led by improvement in Europe, Moody’s Investors Service said Tuesday.

The default rate, which is based on the number of issuers defaulting over the previous 12 months compared with the total universe of bonds, has been declining since January 2002.

Junk bonds are those rated below investment grade. Over the last two years, lower interest rates have allowed many indebted companies to refinance, giving them more financial breathing room. This year, an improving economy and rising stock markets also have bolstered companies’ finances.

Corporate cost cutting also has helped, said David Hamilton, director of corporate default research at Moody’s.

He predicted that “by the third quarter of next year, the default rate will be down to its historical average of about 4%” for the first time since 1999.

Worldwide, health-care companies have led all industries in defaults this year, with $4.9 billion of bonds accounting for 16% of the dollar total.

Individual defaults were highest in the telecommunications industry, with 10 issuers defaulting on $4.5 billion, Moody’s said.

The total of defaulting issuers in the first nine months of 2003 fell to 66 companies with $30.3 billion of debt, about half of the 118 issuers defaulting on $134.8 billion in the same period in 2002, Moody’s said.

Declining default risk has encouraged more investors to buy junk bonds this year. The yield on an index of 100 junk issues tracked by KDP Investment Advisors has fallen from 10.77% at the start of the year to 8.25% on Tuesday, near the lowest level in five years.

The average junk bond mutual fund posted a total return (interest earnings plus or minus change in market value) of 17.4% in the first nine months, according to fund tracker Morningstar Inc. in Chicago.