High-Yield Debt Defaults at Incredible 1 Percent Pace in 2010

For the first five months of 2010, there have been just nine high-yield debt issuer defaults, representing an annual pace of defaults of just 1 percent, according to a report by Fitch Ratings.  The nine defaults affected a total of $1.7 billion of bonds.  Compare that to the 151 issuer defaults in 2009 that affected a record combined $118.6 in bonds, and the difference is astonishing.  The default rate in 2009 was 13.7 percent.

The report by Fitch Ratings examines the reasons why high-yield corporate defaults have all but disappeared, and why this stunning reversal does not necessarily portend that happy days are here again.  If nothing else, the data prove that high-yield corporate debt issuers are perhaps more sensitive than any other investment arena to macroeconomic and capital market developments.  Thus, the recent Eurozone debt crisis and questions about the sustainability of the economic recovery through 2011 and 2012, without the aid of heavy doses of government stimulus, may negatively affect high-yield bonds.

Still, the dramatically low 2010 default rate is remarkable, and has been produced by several factors.  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.

Fitch had forecast a default rate for 2010 of 6−7 percent, well below 2009’s 13.7 percent, but still elevated on a historical basis. 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. In years when the U.S. high yield default rate has run below 2 percent, U.S. GDP growth has averaged 3.5 percent. Fitch’s forecast, developed late in 2009, assumed weaker growth for 2010, on the order of 2 percent. Even so the 1 percent run rate is by all accounts extremely low.

To view Fitch Ratings’s report, please click on the following link [registration may be required]: The Extreme Credit Cycle – Making Sense of a 1% U.S. High Yield Default Rate.