High Yield Defaults Surge Higher After Quiet Onset of Summer
By Rom Badilla, CFA
September 6, 2012
The spread or yield differential between High Yield and U.S. Treasuries, which represents the creditworthiness of speculative grade issuers, continues to tighten as markets rally and flip the risk-on switch. As a result of the spread tightening which infers that the market expects a lower probability of default, High Yield continues to outperform their risk-free counterparts. The spread on the Barclays U.S. High Yield Index is currently at 572 basis points and is near the tights for the year. Similarly, the J.P. Morgan High Yield spread is marked at 633 basis points over Treasuries.
Despite the stellar outperformance, the fundamentals are painting a different picture as default activity in August was high according to research provided by J.P. Morgan. In their latest, “Global High Yield and Leveraged Loan Research – Default Monitor report”, August was an active month as four High Yield companies defaulted totaling $2.14 billion. This surge in defaults surpasses July’s volume as only two companies defaulted totaling $381.8 million while no High Yield companies defaulted in June.
The largest High Yield issuer to default in August was ATP Oil & Gas Corporation. which has $1.5 billion in a single bond outstanding. ATP’s lone bond featured an 11.875% Coupon Maturing May 5, 2015 according to Trade Monster’s Bond Trading Center. The bond was downgraded by Standard & Poor’s rating agency to ‘CCC’ on August 1 before the company filed for bankruptcy on August 17. This is the second largest bond issuer to default in 2012 behind Residential Capital Corp that had $2.8 billion in bonds outstanding.
KV Pharmaceutical which has $225 million in bonds outstanding filed for Chapter 11 bankruptcy protection. Broadview Network Holdings defaulted on $300 million bonds outstanding.
Life Care Holdings missed an interest payment according to JP Morgan’s report. The operator of long-term care hospitals had one bond outstanding totaling $150 million that paid a 9.25% coupon and a final maturity of August 15, 2013 according to Trade Monster. In addition, they had close to 300 million in other outstanding loans to institutional investors.
The demise of these four issuers in August increases the trailing 12-month rate of default for High Yield issuers. August activity brings the par-weighted high yield default rate, which takes into account the dollar amounts, to 2.13% from 1.95% in July. The issuer-weighted default rate increased as well to 3.08% in August from 2.67%.
Despite the significant uptick, the default rate for both measures remains well below historical monthly averages. For the past five years, the par-weighted and issuer-weighted default rate monthly average stands at 3.12% and 3.91%, respectively.
As for credit ratings changes, the number of issuers that experienced a downgrade by the agencies outnumbered the number that went through an upgrade for the third straight month. According to J.P. Morgan, 34 issuers were downgraded versus 28 companies that were upgraded. The tally in August increases the total for 2012 to 236 downgraded issuers while the number of companies improving their prospects in terms of creditworthiness edged higher to 249.
The total volume of bonds that were upgraded totaled 25.4 billion. Conversely, the total for downgrades in August was at $34.0 billion which is the second largest in the past 16 months, just shy of the $34.8 billion print set in February 2012.
In addition, three issuers entered August as speculative grade but left as Rising Stars since they were upgraded to the Investment Grade space. The three Rising Stars totaled $15 billion which pales in comparison to the $16.5 billion that were downgraded out of the Investment Grade space. These “Fallen Angels” encompassed two companies, one of which included the ArcelorMittal. The steel manufacturing company that was downgraded into the High Yield universe accounted for the majority of the Fallen Angel volume at $15 billion.
For 2012, the number of Rising Stars exceeds the amount of Fallen Angels. 21 issuers totaling $45.4 billion improved their credit ratings to Investment Grade space while only $23.1 billion which includes 10 issuers fell down to High Yield.
Visit Bondsquawk on Facebook!
The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of Bondsquawk or its employees.