THE US is heading for a surge in bankruptcies and a dramatic increase in corporate debt default as the number of companies with bonds rated at the lowest end of the junk bond scale reaches record levels.

More than 45 per cent of newly issued junk bonds are rated CCC, according to bond market analysts at Standard & Poor’s (S&P), a dramatic increase since 2003 when 30 per cent of the junk bond market was made up of companies that were a notch away from default.

“Whenever the proportion of new issuances trading at triple C rises above 30 per cent, there is cause for concern,” said Diane Vazza, head of global fixed income research at S&P.

If a company’s debt is rated at CC or CCC, there is a 30 per cent likelihood that it will fail within a year, Ms Vazza said, and means the greater the number of companies rated at the bottom of the junk bond scale, the greater the number of defaults in the next 12 months.

It is likely that the outlook for junk bond issuers will improve slightly this year, according to the S&P’s research. But the improvement will only represent a calm before the storm because the number of defaults and bankruptcies is expected to increase dramatically by the end of next year.

“This is how we see the cycle going forward,” Ms Vazza said.

The number of companies in the junk bond danger zone is likely to continue to grow this year because investors are pouring record sums into the junk bond market while the conditions are favourable. Today a company can issue junk bonds at a cost of 303-basis points above the cost of 10-year US Treasury bonds, which is considered cheap.

“These are awesome supply conditions.” Ms Vazza said. “Last year spreads were at 411 basis points, in 2003 it was 621 and in 2001 it was 773,” she added.

“So you can see why people are attracted to investing in junk bonds today.”

The types of companies that could be expected to file for Chapter 11 bankruptcy protection in the next two years because of the debt status include some household names.

Levi Strauss, the troubled jeans maker, is on S&P’s list of junk bond issuers with a negative outlook. It has more than $2 billion (£1.04 billion) of debt rated at CCC. Default, or D, is a notch below CCC. Mitsubishi Motors Corporation of Japan is also on the list with $386 million of debt rated at CC.

In the US, companies can apply for court protection from creditors if they file for bankruptcy under Chapter 11 rules. In 2002 there were a record number of Chapter 11 filings by value in the US as WorldCom, the telecoms company, United Airlines, the international carrier, Conseco, Adelphia Communications, Kmart and NTL all defaulted.

WorldCom is the record holder because the company had assets worth more than $103 billion on the day before its default and is credited with a bankruptcy worth $11 billion. However, the number of bankruptcies is running at a record low in the US at present.

So far this year there have been 15, the lowest at this point in the year since 1997.

Junk bond defaults are also running at a low with 1.8 per cent of issuers in default, down from 2.3 per cent last year. Over a 30-year period 4.9 per cent of all junk bond issuers default, which means the current number is well below average.

“But the problems will come home to roost in 2006,” Ms Vazza said.

“There will be a definite peak in defaults. The junk bond market is on the turn.”

MOST LIKELY TO DEFAULT

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