Markets

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

Investors worried by a potential second wave of defaults in the U.S. should be even more concerned about emerging markets.

Moody's Investors Service says default rates currently stand at about 4 percent and could soar to as high as 14.9 percent by the end of the year under the most pessimistic scenario, Bloomberg News reports today. Its best-case projection is a 5.05 percent rate.

Edward Altman, New York University professor and creator of the widely used Z-Score method for predicting bankruptcies, has also forecast rising U.S. defaults this year, saying in January that recession could follow even with a rate of less than 10 percent, given the increase in debt since the financial crisis.

Altman, a specialist in credit markets, hasn't been able to create successful default rate statistics for emerging markets due to a lack of historical data, he told an audience at Hong Kong University last year. However, it was safe to assume that they would normally exceed those of developed markets such as the U.S., he concluded.

If that's the case, there's trouble on the way. According to Standard & Poor's, emerging markets recorded their highest number of defaults for 11 years in 2015, a tally of 26. The Bank of America Merrill Lynch High Yield Emerging Markets Corporate Plus index currently comprises 696 bonds, a number that's risen from 346 eight years ago. Based on those numbers, the delinquency rate stands at only 3.7 percent (though the S&P figures don't capture the entire universe of defaults). 

Second Wave
The amount of defaulted debt in emerging markets is unprecedented. So is the amount of debt.
Source: Bloomberg

A study by Moody's published in February 2009 showed that the default rate among high-yield emerging-markets issues could reach as high as 22 percent in the five years following severe banking and sovereign crises. So far, most countries in the asset class have suffered currency and liquidity crises but have skirted the more severe sovereign and banking kind.

A further cause for concern: Fitch Ratings said in January that 24 percent of companies in seven of the biggest emerging markets have raised money offshore. That increases their vulnerability to weakening currencies, an issue that's dogging Chinese issuers. Fitch also said that the share of banks and sovereign ratings on negative outlook is at the highest since 2009.

Priced In?
Spreads of emerging market high-yield bonds are still far below the highs reached in the last crisis
Source: Bloomberg; Bank of America Merrill Lynch indexes

The rating company's analysis of Brazil, India, Indonesia, Mexico, Russia, South Africa and Turkey shows that private-sector debt rose to an estimated 77 percent of GDP at the end of 2014, up from 46 percent in 2005.

Corporate defaults increased to a record in Brazil last year. China has also seen delinquencies climb exponentially, with at least 12 companies missing payments on bonds in the past two years.

If history is any guide, there's a lot more to come. Another wave of defaults in the U.S. will trigger a tsunami in emerging markets.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net