Rising Tally of Weakest Junk

The junk bond market is getting junkier, which may be a reason many investors are shunning those securities, a new report suggests.

A record $172 billion of U.S. corporate junk bonds, or 27% of the total, had ratings of Caa or lower at the end of June, according to credit-rating firm Moody’s Investors Service.

A Caa rating is the seventh-lowest junk rating and indicates substantial risk of default. All junk bonds are considered to be below investment grade in quality.

In 1998, by comparison, $30 billion of junk bonds, or 8% of the total, had the lowest ratings, Moody’s said.

The explosion in the tally of lowest-rated junk issues reflects the collapse of the telecommunications sector and the troubles of many other debt-laden companies since the economy began to slow in 2001.

The Caa-rated junk universe has grown at a 47% annualized rate since 1998, Moody’s said.

In recent weeks, junk bonds in general have suffered a sharp sell-off as investors have pulled away from the market, despite yields of 10% or higher on many securities.

The rash of corporate accounting scandals has spooked investors and raised concerns about a new surge in corporate failures if the true financial condition of many companies has been obscured.

But Moody’s and rival ratings firm Standard & Poor’s expect junk bond default rates to fall rather than rise, reflecting an improving economy. The U.S. junk default rate slipped in June to 9.62% of outstanding bonds from 9.72% in May, S&P; said. That is a 12-month annualized rate.

As for the surge in the lowest-rated tier of junk bonds, “the hope is that most companies that are susceptible to such a rapid slide in credit quality have already been exposed,” said John Puchalla, economist at Moody’s in New York.

“That being said, there’s a lot of uncertainty out there with respect to just how many more accounting restatements might arise,” he said.