BERTONCINI Sergio , Strategy and Economic Research at Amundi Milan
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A steep dive in default rates of US HY recorded so far in 2017
2017 H1 saw quite a turn to the south in default rates of US speculative grade bonds: the trend came mostly expected, as all major indicators leading bankruptcies rates of US HY companies were pointing to a peak at the very beginning of the year and to a subsequent, rapid fall. As recent Moody’s data confirm, the fall has actually accelerated in the very last months of H1 2017. January saw a 5.9% DR for US speculative grade companies, the peak of what may be referred to as the current default “mini-cycle”. Then, the rate fell to 4.7% in March and touched 3.8% in June: rating agency last forecasts point to the 3% area for December this year, very much in line with our own regressed forecasts, based on indicators leading defaults. A more gentle drop should therefore take place in the very next months, as the steep fall of the trailing 12-month default rate by June took place because of the substitution of a very bad H1 2016 with the much better numbers recorded in H1 this year. In terms of defaulted debt, in fact, in the first six months of 2017 US HY recorded less than one third of the amount experimented in H1 2016, while the second part of this year should diverge less with respect to the same period of 2016.
The commodity-driven cycle is closer to its end…
Both upward and downward trends of the current “mini-cycle” were not recession and/or financial crisis-driven but, instead, almost entirely commodity-driven: if energy and material sector companies are excluded from last two years’ computation, in fact, default rates remained quite stable and close to the low levels of previous years’. The reported chart shows that the recovery of the energy sector in terms of decreasing number of bankruptcies should proceed in the next quarters, lagging by around one year the massive drop in its distressed ratio. The distress ratio (the percentage of bonds trading above 1,000 b.p. spread over treasuries) of the whole universe of US speculative grade is currently close to the lows of 2014, therefore pointing to a 3% threshold in a 6 to 9-month time. A look at defaults by rating categories is encouraging, too. High quality speculative grade bonds, namely the BB-rated universe, moved down to zero DR since January this year, while B-rated bonds followed to the same level just in the following months. In a nutshell, therefore, default rates are currently concentrated in the lowest rating category only, namely the CCC-rated names.
…Therefore, what to expect now?
As top down factors point to a further fall of DR and commodity sectors’ woes recede, the question is now about which sectors may move to the frontline of defaulted issuers and lead the trend in the next months and quarters. At the moment, excluding commodity, the retail sector is showing some stress, although with just a few defaults recorded in the very last month and a distress ratio at 17%, currently the highest among US major segments. According to the very last number published by Fitch, however, US retail sector is currently suffering from a still very limited DR, namely a 1.8%. Moody’s is forecasting a 4.5% DR in one year time for retailers, while Media sector has been recently revised up to the 7% in 12-month time: in a nutshell a very limited rise for the two sectors, respectively representing 3.7% and 4.7% of the US HY bond market debt, a lower weight than the 14% still represented by energy and the 5% by metals & mining. A look at recent trends in debt supply sees refinancing recovering ground with respect to M&A and spending items among the purposes of new bonds: this is an encouraging signal, taking also into account the limited amount of US companies’ refinancing needs in the next two years. In conclusion, therefore, default rates are likely to proceed in their falling trend in the US over the very next quarters, although at a slower pace with respect to the trend delivered so far in 2017: this scenario seems to be consistent not only with indications from top down factors but also looking at bottom up and market factors. The return of defaults to lower levels in the US should be accompanied by a scenario remaining quite benign for European High yield: Europe did not join the US in the commodity driven mini cycle of the last few years and remained close to cyclical low levels which should be confirmed also in the next quarters.