Crumbling bond market sounds distress alarm

By Walden Siew and Dena Aubin - Analysis

NEW YORK (Reuters) - Corporate bond investors are bracing for growing defaults and record company bankruptcies starting in 2009 as the volume of distressed debt climbs past $184 billion, an all-time high.

More corporate debt is now trading at distressed levels than in 2002, when there was $165 billion of distressed corporate debt following the last bankruptcy boom, according to Moody's Investors Service data.

Nearly one in three junk bonds trade at levels known as "distressed," suggesting a serious risk of default. Even higher-rated corporate bonds have sunk to distressed levels in near-record volumes.

Automakers General Motors Corp (GM.N) and Ford Motor Co (F.N) lost their investment grade status in 2005 and their bonds have since plummeted to distressed credit levels.

Now bonds of financial firms such as CIT Group Inc (CIT.N) National City Corp NCC.N and bond insurers like MBIA Inc (MBI.N) are trading as though investors expect them to follow that ignominious path.

"It's the fast deterioration of some of the higher-rated credits that is most alarming," said Jason Brady, a managing director at Thornburg Investment Management. "From a dollar standpoint, we're going to see a record wave of defaults and bankruptcies."

Spokespersons at CIT and National City didn't immediately return phone calls seeking comment about how their debt is trading. MBIA's spokeswoman cited the company's policy of not commenting on its bond market performance.

The total amount of high-yield debt trading at distressed levels is now $147 billion, while investment-grade distressed debt is about $37 billion, according to Moody's credit strategy group.

"The market is pricing in pretty ugly bankruptcy scenarios," said Brady from his Santa Fe, New Mexico, office, where the firm oversees $4 billion in fixed-income assets. "The dramatic bank deterioration is coinciding with the overall level of distress."

A slumping economy, high oil prices and tighter credit conditions are putting a greater squeeze on corporations and impacting their ability to manage and pay off their debt.

Credit crisis fears, especially in the financial sector, have pushed yields on several companies into distressed territory recently, though rating agencies still assign them low default risk.

High-grade companies trading at distressed levels in recent days include Washington Mutual Inc WM.N, CIT and Ambac Financial Group (ABK.N), according to MarketAxess.

Ambac's spokeswoman declined to comment, while Washington Mutual didn't immediately return a call.

In all, about 7.5 percent of high-yield and investment-grade debt combined is distressed, the same level seen during the credit downturn of 2000 to 2002, when bankruptcies soared, according to data from research firm Leverage World.

Public company bankruptcy filings climbed to 179 in 2000 and rose to a record 263 in 2001, according to bankruptcy court records.