Where have all the defaults gone?

Where have all the defaults gone?

Defaults in the high yield bond market are supposed to peak 12 months after a crisis. But for the first month in two years there were no high yield defaults in April. What is going on and why are distressed ratios so low?

Figure 1 below shows the percentage of the US dollar high-yield bond market that is distressed, defined as having a spread of more than 1,000 basis points. At 2%, this distress ratio is currently close to its record lows. So, is the fundamental picture really that strong, or is the market being complacent?


Figure 1: High-yield distress ratio


Source: BofA Global Research, ICE Data Services LLC. Defines as proportion of face value of bonds in the DM USD high yield index with option-adjusted spread above 1,000 bps.


On the fundamental side, Bank of America is currently projecting a 30% EBITDA growth over the next 12 months, which would go down as one of the best periods on record. It is true that this is off a low base, but if we look a little broader, net leverage is expected to drop to below four times over the next year, well inside long-term averages.


Interest coverage is also on its way to record highs, which would cushion against a likely rising-rate environment. Raw materials are being passed through in most places, protecting margins, and technology continues to play a role at keeping costs under control. Finally, rating upgrades within high yield are breaking new records.


So, fundamentals are remarkably strong. Is the market being complacent?


To some extent it always is, it’s just a matter of how widespread that is. The best way to analyse this is to look at the levels of dispersion in the market, and currently there isn’t very much.


Not all bonds are created equal, but the market currently seems to be pricing them so. That is why we believe a bottom-up driven, high-conviction portfolio is so important in these markets.


Separating the haves from the have-nots today will lay the foundation for future alpha generation when defaults eventually do come back.

Mark Benbow

Investment Manager, Fixed Income

Mark Benbow is an investment manager in the Fixed Income team. 

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