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Defaults on speculative-grade corporate bonds will skyrocket in 2009 to about a 15% annual rate. That's well above 2008’s 4% rate and the record 10.7% set in 1991. Making the situation worse is a severe recession and the huge load of maturing speculative- and investment-grade debt this year -- about $760 billion, or 12% of outstanding U.S. corporate debt.

Approximately 40% of the bonds due to mature are rated speculative, and companies will have to pay high rates to roll over the debt. Rates are around 17%, up from 9% a year ago. Yields on bonds rated investment grade aren't as high, averaging 8%. But that's still five percentage points above comparable Treasury debt, a gap that typically is about two percentage points. And businesses face competition with the Treasury, which has its own huge financing load in light of a federal budget deficit expected to hit $1.2 trillion this year.

Defaults on debt and resulting bankruptcies are downside risks, among the conditions that threaten to worsen the credit crisis and extend an already severe recession.

Among investors, a general aversion to risk makes for a big obstacle for debt-laden companies. The lowest-rated companies will be highly challenged to find buyers even at these high yields.

The climate for high-quality borrowers seems to be improving. The volume of bond deals picked up in December and January. Meanwhile, the spread against Treasuries has narrowed by a full percentage point since mid-December.
Ratings

The most important indicator of a bond’s potential to default is its ranking by one or both of the two most recognized bond-rating services.

Moody’s Investors Service and Standard & Poor’s are the two premiere bond-rating services. If one of these services does not rate a bond, I would pass on it.

The two companies study bond issuers and rate them on their creditworthiness. Here is an explanation of their rankings:
Investment Grade – Highest Grade:
•     Moody's – Aaa
These bonds are judged to be of the best quality. They carry the smallest degree of risk. Interest payments are protected by an exceptionally stable margin and principal is secure.
•     S&P – AAA
The issuer’s capacity to meet its financial obligation on the bond is extremely strong.
Investment Grade – High Grade
•     Moody's – Aa1, Aa2, Aa3
These bonds are judged to be of high quality by all standards. Margins of protection may not be as large as in Aaa securities.
•     S&P – AA+, AA, AA-
The issuer’s capacity to meet its financial obligation on the bond is very strong.
Upper Medium Grade
•     Moody's – A1, A2, A3
These bonds possess many favorable investment attributes. Factors giving security to principal and interest are considered adequate.
•     S&P – A+, A, A-
Although these bonds are somewhat more susceptible to the adverse effects of changing economic conditions, the issuer’s capacity to meet its financial obligations is strong.
Medium Grade
•     Moody's – Baa1, Baa2, Baa3
The bonds lack outstanding investment characteristics and have speculative characteristics as well.
•     S&P – BBB+, BBB, BBB-
Adverse economic conditions are more likely to lead to a weakened capacity of the issuer to meet its financial commitment.
Both services continue their rankings for lower rated bonds, but unless you are into speculating, I suggest you stick with issues that fall into one of the categories above.
Remember, a bond’s rating can change at any time if circumstances change. Just because the services rated a bond at one level when issued doesn’t mean it can’t lower the rating if some adverse condition arises.
Understanding Yield
The term you will hear about bonds the most is their yield and it can be the most confusing. I broke this concept out separately because there are really three different types of yield to explain:

1.      Nominal Yield – This is the coupon or interest rate. Nothing else is factored in to this number. It is actually not very helpful.
2.      Current Yield – The current yield considers the current market price of the bond, which may be different from the par value and gives you a different return on that basis.

For example, if you bought a $1,000 par value bond with an annual coupon rate of 6% ($1,000 x 0.06 = $60) on the open market for $800, your yield would be 7.5% because you would still be earning the $60, but on $800 ($60 / $800 = 7.5%) instead of $1,000.
3.     Yield to Maturity – Yield to Maturity is the most complicated, but the most useful calculation. It considers the current market price, the coupon rate, the time to maturity and assumes that interest payments are reinvested at the bond’s coupon rate. It is a very complicate calculation best done with a computer program or programmable business calculator. However, when you hear the media talking about a bond’s “yield” it is usually this number they are talking about.

If you suffered losses from defaulted bonds, sold to you by a brokerage firm, call the Soreide Law Group today. Soreide Law Group represents investors that were defrauded by their brokerage firms accross the US before the Financial Industry Regulatory Authority. Call 888-760-6552: It is our pleasure to review your case for free.