High yield defaults below average but yields are lower too says Deutschebank study

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.

3 thoughts on “High yield defaults below average but yields are lower too says Deutschebank study”

  1. Noo 2 Economics says:

    I thought Marxism didn’t have anything against free markets? It simply suggested profits should be paid to the proletariat whether they were workers, unemployed or disabled. You seem to be describing a centrally planned economy which has more in common with communism than Marxism.

    Your “bring back capitalism” refrain reads more to me like “de-regulate and let the price mechanism take over”. Unfortunately, we have witnessed the effects of “light touch regulation” with the debacle that started in 2008/2009 with the likes of RBS, Nat West, Halifax/HBOS, Northern Rock etc.
    Don’t get me wrong, I would’ve happily followed capitalist rules and stood by whilst all that lot and the rest went to the wall, rather than this ridiculous socialising of their losses whilst privatisation of their profits (Virgin money) continues leaving Sovereigns paralysed and unable to deal with any further crises as they continue to struggle to deal with the failure of capitalism that occurred in 2008/2009.

    I think you are wrong in your central argument – that the BOE doesn’t care about the housing market price rises. As Shakespeare’s Queen Gertrude said “The lady doth protest too much methinks”.

    The BOE are very worried about house prices otherwise why would they be happy with the Mortgage Market Review and then choosing to add to it the “affordability stress tests” which are clearly aimed at tempering the price rises part of the housing market.

    As to why the BOE is worried, I believe it’s worried because of the developing risk on bank balance sheets which exploded so spectacularly just 6 years ago and it knows this time the Government is fresh out of ammunition so quite the contrary, the BOE is very worried about potential risks developing on bank balance sheets as a result of potentially unsustainable house price rises so it’s getting first bat in and trying to gently take the heat out of the market before everything boils over again., thereby removing one potential cause of the next global shock (assuming other central banks behave similarly). Is it doing enough? Certainly not! Income multiple should be 3.5 times earnings with no more than 80% loan to value and affordability calculated against a rate of 8% pa, but then that’s the regulation you dislike but it would create a stable, if sluggish market.

    By the way the source of the next global shock? My money is on fixed income, the global Central Banks have kept rates artificially too low for too long which has led to very frothy fixed income markets as the search for yield extends. It’s going to be very difficult to “normalise” rates without causing a massive negative event in fixed income markets which, of course, will then spill over into equities and thence to the real economies.

    I could write more but it’s my bed time.

    1. Anonymous says:

      We have seen no regulation because the market regulates. They should have let go bust but instead our kids were put in hock to save them. By letting them go bust we would not see the shenanigans by banks we see – house prices would be lower and, after a hiatus and readjustment, we would be the fastest growing country in the developed world.

      With capitalism we would not have seen the entirely reckless (fraudulent) lending we saw and see. Problem wouldn;t have happened in the first place.

      If Carney cared about house prices he would insist HTB be cancelled forthwith. Prices were flat for getting on for 3 years until HTB. The mkt was in a state of collapse. Prices were about to tumble. Then electioneering got going. Without easy lending prices will correct – in all senses.

      It may be The Fed loses control over rates. I’m not so sure. China is on a knife edge.

      Thank you for your extensive reply.

  2. Anonymous says:

    Assume joint. Pathetic huh?

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