U.S. junk bond rally bypasses riskiest companies

By Dena Aubin

NEW YORK, Feb 10 (Reuters) - A rally in junk bonds is opening funding to a handful of U.S. companies, but a credit freeze lingers for dozens of others, threatening to push bond defaults to Great Depression levels this year.

Even after junk bonds overall posted their best January performance in years, the weakest names are still being crushed with borrowing costs going through the ceiling as investors shun names at risk of default.

"It's not back to normal yet," said Andrew Feltus, portfolio manager at Pioneer Investments in Boston. "There's a lot of distressed issues out there and there's not that much demand for them."

Dozens of companies, ranging from General Motors (GM.N) to Rite Aid Corp (RAD.N), have bonds trading at yields of more than 30 percent, meaning they would have to pay about that much to sell or refinance debt.

Nearly one-quarter of all high-yield bonds are trading below 40 cents on the dollar as weak companies fight a deepening recession, Morgan Stanley said in a recent report.

If borrowing costs stay elevated, "high-yield companies will have trouble operating profitably, let alone refinancing themselves," Morgan Stanley said.

DEFAULTS QUADRUPLE

Bankruptcies have already surged as consumers reeling from layoffs and home foreclosures rein in spending, pushing corporate sales into a tailspin.

The worsening recession prompted Moody's Investors Service to raise its default forecast on Tuesday, with both the U.S. and global rates now expected to peak at 16.4 percent in the final quarter. That rate would top records set in the Great Depression, when the U.S. junk bond default rate hit 15.9 percent and the global rate peaked at 15.4 percent.

The global default rate has already quadrupled to 4.8 percent from 1.1 percent a year ago, Moody's said.

Rising defaults could counteract benefits of a bank rescue plan rolled out on Tuesday and a huge economic stimulus package approved by the U.S. Senate to ease the worst recession in 70 years. For details on both plans click on [ID:nLA744901].

Junk bonds for months have been pricing in massive defaults, with their yields surging to record highs relative to Treasuries. The spread between Treasury and junk bond yields has narrowed from a peak of over 2000 basis points but is still much higher than in the last two recessions, said Kenneth Emery, director of corporate default research for Moody's.

"The high-yield bond spread right now is still around 1600 basis points and in the previous two recessions it barely reached 1000 basis points and then quickly declined," he said. "The ability to get access to the capital market is extremely tight."

CONSUMER COMPANIES SHUNNED

U.S. junk-rated companies sold about $4.9 billion of bonds in January, more than the previous five months combined. But many of the sales were from higher-quality companies and they still had to offer double-digit yields.