Neuberger Berman Says Junk Bonds Fairly Paid for Defaults

  • U.S. default rate may rise to 4% in 2017, O'Reilly says
  • Energy, commodity companies to drive defaults on price drop

Neuberger Berman Group LLC says investors in speculative-grade companies are getting sufficient compensation for U.S. defaults that it expects to expand below historical averages.

The yield on non-investment grade U.S. bonds rose to the highest this year at 8.4 percent on Oct. 2, up from 5.7 percent in 2014, according to Bank of America Merrill Lynch data.

"We think those are attractive yields relative to the outlook for defaults," said Tom O’Reilly, the co-head of non-investment grade fixed income at the money manager that was once part of Lehman Brothers Holdings. The increase in failures "will be very slow,” he said, adding that the rate of junk-rated notes that default in the U.S. may rise to 4 percent of all such securities by 2017.

Stresses in global credit markets have emerged as China’s weakest expansion in a quarter century has prompted a rout in commodities and emerging-market assets. Moody’s Investors Service said this week that the U.S speculative-grade default rate rose to 2.5 percent in the third quarter from 2.1 percent three months earlier as oil and gas companies remain under pressure.

“You are getting compensated for defaults to start moving up," O’Reilly said in an interview in Tokyo on Wednesday. The U.S. default rate will probably hover around 3 percent in the next couple of years after running at 1 to 2 percent for about the past five years, and may touch 4 percent in 2017, he said.

Coal, Steel

O’Reilly, who helps oversee about $30 billion in speculative-bonds at Neuberger, is underweight energy companies and doesn’t own any “coal and steel names” in the metallurgical coal area.

"The lower-quality companies in today’s type of oil and gas environment will have a hard time avoiding bankruptcy because their capital structures just do not work with these prices," he said. Black Elk Energy Offshore Operations LLC, Goodrich Petroleum Corporation and Samson Investment Company were among six defaults in the oil and gas industry in the third quarter, according to Moody’s.

Outside of energy and commodities, O’Reilly said markets for speculative bonds remain “fundamentally very good.” Neuberger has only had one default in high-yield bond portfolios in 20 years, according to O’Reilly, who downplayed talk of the “end of high yield.”

O’Reilly joined Neuberger in 1997 and was a high-yield analyst for eight years before that. Neuberger had $237 billion in total assets under management at the end of September including $105 billion in fixed income.

“We continue to be in a global environment where yields across the world are relatively low and I don’t think that changes any time soon,” he said. “We continue to see appetite, demand from investors.”

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