Fitch Warns High-Yield Default Rate Set To Jump
As every 'real' corporate bond manager knows (as opposed to playing one on television), forecasting from historical defaults is a fool's errand as the process is entirely cyclical and non-stationary.
The fact that default rates have been low for 4 years (thanks to an overwhelming flood of liquidity-driven demand for yield) is of absolutely no use when pricing discounted cashflows into the future. However, as Fitch warns, a jump in US high-yield default rates looms. There have been 10 LBO related bond defaults thus far in 2014, compared with nine for all of 2013. While most sectors remain relatively clam, the utilities and chemicals sectors are seeing huge spikes in defaults.
A potential bankruptcy filing from another struggling giant, Caesars Entertainment Operating Co., would propel the trailing 12-month US high yield default rate to 3.4% from its June perch of 2.7%, according to Fitch Ratings. With its $12.9 billion in bonds in Fitch's default index, the gaming company's impact on the default rate is pronounced - similar to Energy Future Holdings' (EFH) April bankruptcy. Caesars also adds to notable trends of busted LBOs and the exclusive camp of serial defaulters.
There have been 10 LBO related bond defaults thus far in 2014, compared with nine for all of 2013. The failed LBOs affected $21.8 billion in bonds this year and 26% of all bond defaults since 2008. Caesars would bring the latter tally to 29%. In addition, a Caesars filing would follow two prior restructurings via distressed debt exchanges (DDEs). Since 2008, 24% of issuers engaged in DDEs have subsequently filed for bankruptcy.
June defaults included Affinion Group, Allen Systems Group, MIG LLC, and Altegrity Inc., bringing the year-to-date high yield default tally to 20 issuers of $23.7 billion in bonds versus an issuer count of 19 and dollar value of $8.4 billion in first-half 2013. July defaults have so far included Essar Steel Algoma and Windsor Petroleum Transport.
At midmonth, approximately $33 billion in high yield bonds were trading at 90% of par or less - a relatively modest 2.9% of the $1.1 trillion in bonds with price data.
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Which explains why, as we noted poreviously, High Yield credit is flashing bright red...
As Barclays Phil Solarz warns,
One of the things that sticks in my mind from 2007 (and I am NOT suggesting a 2007/2008 repeat here) is the fact that the credit markets moved before equity markets....and not just once, but three or four times through 2007 and 2008.
I recall looking at charts like the attached and thinking "why has this correlation broken down?"
Inevitably, the credit markets would be right, and the equity market would eventually catch up and re-establish the correlation.
The chart above shows (the inverse of) the junk-less-10 year spread vs the S&P. The tight correlation of the past 12 months (and actually, the last 3 years) has broken down this month., as we noted previously,
Which in the past has led to equity weakness...
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