Bond Distress Rises as Goldman, JPMorgan Vary on Defaults: Credit Markets
The percentage of corporate bonds considered in distress is at the highest in six months, a sign debt investors expect the economy to slow and defaults to rise.
The number of speculative-grade companies worldwide with yields at least 10 percentage points more than government bonds climbed to 399 this month, or 16.7 percent of the total, the highest share since December, according to Bank of America Merrill Lynch index data. The ratio compares with 9.2 percent on April 30, which was the lowest since November 2007.
Junk bond sales slumped to a 15-month low in June amid concern government efforts to control spiraling budget deficits will hamper global growth and drive up borrowing costs for the neediest borrowers. The 2010 default rate in the U.S. may jump as high as 6 percent by year-end from 1.3 percent now, according to analysts at Goldman Sachs Group Inc.
“The default driver will be a reversal of easy refinancing conditions,” said Charles Himmelberg, chief credit strategist at Goldman Sachs in New York.
JPMorgan Chase & Co. analysts led by high-yield credit strategist Peter Acciavatti wrote June 25 that the default rate will be 2 percent in 2010. The views are diverging as investors weigh the effects of Europe’s sovereign debt crisis and on mounting concern the U.S. economy will tip back into recession.
“I could never have imagined this amount of macro uncertainty,” said Don Ross, who helps oversee $9.5 billion of assets as global strategist for Cleveland-based Titanium Asset Management Corp.
Elsewhere in credit markets, the extra yield investors demand to own corporate bonds rather than government debt is poised to widen the most this quarter since 2008, prices of leveraged loans are set to fall, emerging market debt spreads are headed for their first quarterly increase since the final three months of 2008 and asset-backed debt sales are slowing.
The gap in yields between corporate and government debt ended last week at an average 195 basis points, or 1.95 percentage points, up from 149 at the end of March, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. The last time spreads widened as much was when they expanded by 130 basis points to 489 in the final quarter of 2008, when Lehman Brothers Holdings Inc. collapsed.
The yield on the index, which tracks 8,516 issues with a par value of about $6 trillion, is 3.99 percent, little changed from the end of March and down from 4.4 percent in December.
Returns on company bonds as measured by the Bank of America index average 0.8 percent this month, following a loss of 0.4 percent in May. Year-to-date returns through last week total 4.46 percent, compared with a loss of 6.1 percent for the MSCI World Index of stocks.
High-yield issuance globally has totaled $8.3 billion in June following $8.6 billion in May, the least since March 2009, compared with an average of $32.4 billion in the previous four months, according to data compiled by Bloomberg.
“Risk aversion remains elevated,” JPMorgan debt strategists including Srini Ramaswamy in New York said in the bank’s U.S. fixed-income report dated June 25. In terms of Europe’s sovereign debt crisis, “we are at an inflection point with respect to the potential impact on U.S. economic growth, which is likely to cause fixed income markets to remain highly reactive to the tone of economic data,” they said.
The bank increased its year-end investment-grade spread forecast to 150 basis points from 125.
The Commerce Department said June 25 that the U.S. economy grew at a 2.7 percent annual rate in the first quarter, less than the 3 percent previously calculated, reflecting a smaller gain in consumer spending and a bigger trade gap.
The S&P/LSTA US Leveraged Loan 100 Index, which tracks the 100 largest dollar-denominated first-lien leveraged loans, rose 0.02 cent to 88.81 cents on the dollar last week. The index has lost 3.2 percent this quarter, after gaining 4.7 percent in the first three months of the year.
In emerging markets, relative yields widened the most last week in more than a month. Spreads rose 12 basis points to 321 basis points, the biggest weekly increase since climbing 42 basis points in the period ended May 21, according to JPMorgan’s Emerging Market Bond index. Spreads rose 3 basis points today to 324 basis points.
Yield Gap Rises
For the quarter, the gap in yields has risen 72 basis points, the first increase since it widened 277 basis points in the three months ended Dec. 31, 2008.
In the asset-backed market, U.S. supply will total about $25 billion of bonds this quarter, down from $30 billion in the first quarter, JPMorgan strategists estimate. They predict sales will total $105 billion for the year.
Defaults on high-yield debt in the U.S. will drop to 2.7 percent by the end of the year, or as high as 5.8 percent under a “pessimistic” economic scenario, from 7.9 percent in May, Moody’s Investors Service said June 6. Standard & Poor’s forecast on June 4 that the pace of defaults will decline to 5 percent, from 6.7 percent at the end of last month. The rate may increase to 6.9 percent by 2011 under S&P’s pessimistic scenario.
Goldman Sachs’s default forecast translates into about 58 defaults in the next two quarters, compared with 16 from January through June, based on Moody’s data of 1,241 issuers.
S&P said two global corporate issuers defaulted last week, boosting the year-to-date 2010 tally to 41. By region, 29 issuers have defaulted in the U.S., two in Europe, four in the emerging markets, and six in the other developed regions, such as Australia, Canada, Japan, and New Zealand.
Distressed exchanges accounted for 13 defaults, while Chapter 11 filings and missed interest or principal payments are responsible for 11 each, according to S&P. Regulatory directives and receiverships account for one each, and the remaining four defaulted issuers are confidential, it said.
“Residual default risk beyond the one-year forecast horizon could increase because of the significant overhang of surviving leveraged corporate issuers,” S&P said in a June 25 report. “The substantial decline in risk premiums for lower- rated borrowers and the return of what we view as questionable practices and structures in some recent deals, such as raising bond funds to pay out shareholder dividends or sponsors, further raise flags that the optimism might be overdone.”
Junk Debt Returns
Speculative-grade debt has returned 0.09 percent this quarter, the worst performance since losing 17.6 percent in the final three months of 2008, according to Bank of America Merrill Lynch’s U.S. High Yield Master II index. High-yield debt is rated below Baa3 by Moody’s and lower than BBB- by S&P.
Yield spreads rose 8 basis points last week to 690 basis points, up from an almost three-year low of 542 on April 26. The current low default rate and wider spreads make the debt an “excellent buying opportunity,” said Ann Benjamin, Chicago- based chief investment officer of leveraged asset management strategies at Neuberger Berman LLC.
“It’s not like we’re back in the early 2000s when you have over-levered companies with no cash flow,” said Benjamin, who helps oversee $7.5 billion of high-yield bonds and $5 billion in loans. “These are good companies with solid and predictable cash flows.”
Incomes grew faster than spending in May, making it possible for American households to simultaneously increase savings and support the economic recovery. Consumer purchases rose 0.2 percent, exceeding the median forecast of economists surveyed by Bloomberg News, after little change the prior month, Commerce Department figures showed today. Incomes climbed 0.4 percent, and the savings rate increased to the highest level in eight months.
Corporate profits increased 8 percent in the first quarter, the Commerce Department report on June 25 showed. Earnings were up 34 percent from the same time last year, the biggest year- over-year gain since 1984.
Employment fell in June for the first time this year, reflecting a drop in federal census workers as the decennial population count began to wind down, economists said before a report this week. Payrolls declined by 110,000 last month, according to the median estimate of 51 economists surveyed by Bloomberg News ahead of a Labor Department report July 2. Private employment, which excludes government jobs, rose for a sixth consecutive month, the survey showed.
“It’s somewhat self-fulfilling, if the capital markets are willing to finance you, you don’t default,” said Tad Rivelle, head of fixed-income investment at Los Angeles-based TCW Group Inc., which has $115 billion in assets under management. “In the current environment, what seems to be uppermost in investors consciousness is, are we headed for a double dip?”