13th May 2013
The 15th Annual Deustchebank Default study, Analysing a Decade of Record Low High Yield Defaults, has revealed record low yields on high yield bonds in the US, yields close to record lows even in Europe but also remarkably low default rates.
The study notes that in the five years since the financial crisis many risk categories have remained below their long term average default rates. The big divide in terms of defaults is between the bonds of financials and non-financials.
The study authors Jim Reid and Nick Burns say: “Starting with investment grade, we can see that defaults in the 2008-2012 five-year cohort for single-A rated issuers were the highest in this 40+ year period which, from our experience of the annual data back to 1920, means that this is the highest five-year default cohort since the Great Depression in the 1930s. For Aa rated issuers, only the 1984-1988 cohort saw a fractionally higher default than that seen in the past five years.For Baa, Ba and single-B rated issuers we see a much more benign scenario where the 2008-2012 default cohort saw a lower peak than that seen at the peak of both the early 1990s and early 2000s recessions. Given the once in a lifetime stress seen during the global financial crisis this is remarkable.
“Furthermore, it’s interesting to note that the default rate for single-A and Aa rated issuers during the crisis was actually higher than the Baa rated issuer default rate. For Caa-C rated issuers the data history is not as deep with the cohort data only exceeding 30 issuers after the worst of the early 1990s recession was behind us. However, the 2008-12 cohort also saw notably lower Caa-C rated defaults than seen during the early 2000s and early 1990s recessions.”
The report suggests that in the modern era, since the once high yield market became a standalone asset class, rather than just a “fallen angels market”, the past 10 years has seen the lowest period for single-B defaults based on the 2003 cohort.
Reid and Burns, strategists in the Deutsche Bank fixed income research team say this pattern is remarkable, given recent history.
The Financial Times columnist John Authers (behind paywall) has an interesting take saying the study suggests that the benign interest rate environment is allowing even weak firms to service debts and proof themselves against any downturn in the medium term. However this may also mean a distinct lack of creative destruction and the survival of firms that by rights shouldn’t be surviving. These zombie firms may be attracting capital which might be deployed to better effect elsewhere.
However if you have US and European high yield in your portfolio, the risks of default undermining performance are much slimmer than one might expect. Yet is a double edged sword – decent yields are, of course, also more difficult to find.