My junk bond is better than your sovereign bond

There’s a very interesting Fitch report currently making the internet rounds.

It’s about the ‘extreme credit cycle’ taking place in junk, or high-yield bonds.

And boy, is it extreme. The summary:

Just one year after the most volatile and unnerving period on record for the financial markets and for the U.S. economy, the pace of high yield defaults has slowed so dramatically in 2010 that even the most optimistic forecasts do not reflect that defaults are running at a full-year rate of roughly 1%. In the first five months of 2010, there have been nine issuer defaults affecting a combined $1.7 billion in bonds, for a year-to-date par default rate of less than half a percent. In 2009, 151 issuers defaulted on a record $118.6 billion in bonds, producing a 13.7% default rate.

For context, Fitch had been expecting a 2010 default rate of 6 to 7 per cent.

And for even more context, between 1983 and 2007, the cumulative default rate for speculative grade sovereigns was 20 per cent, according to Moody’s data. For investment grade countries it was 0.62 per cent. Which means in 2010, junk bonds defaulted at a lower rate than investment-grade sovereigns in the 24 years pre-financial crisis. In an internet acronym, WTD.

Fitch offers up some ideas to explain what it calls a ‘stunning drop’ :

Early this year Fitch reviewed the key factors that had contributed to the already significant moderation in defaults in the second half of 2009 . . . These ranged from a marked decline in downgrades, to far improved bond market conditions, to the unprecedented quick action by U.S. companies to cut costs, shore up balance sheets, and boost liquidity in response to fears of a prolonged period of sluggish growth. All of these developments had and were expected to continue to put downward pressure on the default rate . . . With the 2010 default rate running significantly below this, Fitch estimates that the economy’s better than expected performance, especially on the consumer spending side, accounts for roughly half the variance between Fitch’s forecast and the pace of defaults this year.

But there’s also the issue of credit availability and the boom in junk issuance this year.

Stripping out the 11 per cent growth of the high-yield market this year would have resulted in a 2010 default rate of 1 per cent, Fitch says. Still very low, but you get the idea. Back to Fitch:

Credit availability is the critical factor bridging the gap between the economic outlook and default risk. Since mid-2009, supported in no small measure by highly accommodative monetary policy, speculative grade bond issuance has been on a tear, even including recent interruptions caused by the sovereign debt crisis in Europe. The high yield market has clearly been a beneficiary of the extraordinary demand for yield product in a very low interest rate environment. In just the first five months of 2010 U.S. issuance has totaled $104 billion, a record pace.

One wonders what governments think of that. You initiate that easy monetary policy — zero per cent interest rates, quantitative easing and the like — and you get investors flocking to junk bonds rather than sovereigns. How very amusing.

Anyway, the concern (as you can probably guess) is what happens when credit markets have to stand on their own:

. . . this decline, while certainly welcomed, also offers uneasy comfort as the global financial markets continue to grapple with serious economic and credit challenges. In the end, the record surge and contraction in high yield defaults shows how very sensitive speculative grade companies are to macroeconomic and capital market developments. This sensitivity became apparent again in recent weeks as the sovereign debt crisis in Europe disrupted issuance and caused spreads to widen to 2010 highs. The critical concern going forward remains the sustainability of economic growth, especially for 2011−2012, when the economy will need to perform without the high octane fuel of fiscal and monetary stimulus programs. However, there is no denying that 2010 is proving to be a benign year for defaults.

The whole Fitch report available here or here.


http://ftalphaville.ft.com/?segid=70409

Unbelievable ridiculous. Investors flocking rather into junk bonds than sovereigns. Ha, ha, ha.