The default rate on high-yield debt is creeping upward.
Moody’s Investors Service said Friday that the global high-yield default rate was 2.4% in July, the highest level in 15 months. Plus, this rate is projected to rise slightly through the first half of next year, according to the research group.
Just how big are defaults? The most recent count and cash volume of defaults are “on a disconcerting uptrend, which has kept investors on edge,” says Benjamin Garber, an economist with Moody’s Capital Markets Research, in a report.
The default rate currently is on pace for 77 defaults on $86 billion in debt in 2015, which is well ahead of last year’s count of 53 defaults on $69 billion in debt.
However, the pace of this increase “does not yet mirror previous credit busts,” Garber adds. The historical average of this rate is 4.6%.
To put today’s situation into perspective, he notes that the last two years when the default rate surpassed 5% en route to double-digit percentage peaks, 1999 and 2009, “the annual count of defaults rose by 106% and 158%, respectively,” he states.
In contrast, the estimated jump in the number of defaults this year stands at 45%.
As for the overall default rate, Moody’s projects it “will remain comfortably” under the 25-year average of 4.6% in Q1 and Q2 of 2016.
There was a steady climb in the default rate from 1997 to 2002 and then a rapid climb in 2008 and 2009. In the first period, the rate expanded over 62 months from 1.3% in April 1997 to 11.1% in May 2002.
This development “was marked by rapidly increasing business investment spending growth despite fading profitability and inefficient use of productive capacity,” Garber said.
Profits shrank and the capacity utilization rate dropped in 1998 and 1999. The related overexpansion “drained corporate incomes as the default rate grinded higher,” the economist says.
In contrast, the capacity utilization rate for the manufacturing sector is up 0.6% on a yearly basis through July 2015, “which benefits corporate bottom lines even at that modest pace of growth,” he adds.
Looking at what happened in eight years ago, the default rate rise played out over 24 months — defaults climbed from 1% in December 2007 to 13.7% in November 2009.
“Comparing current conditions to the last recession, there is now cause for concern as profits from current production falter, likely to expand overall this year at less than 2%,” Garber stated. “But tailwinds lifting the results of industries deriving their sales from the U.S. bring reason for optimism compared to the severe financial market turbulence that created the Great Recession.”
In particular, he notes, the health care and homebuilding sectors are benefiting from rising incomes and regulatory changes, which is producing profits that preserve credit quality.
On the flip side, metals and mining are having a rough time.
While there is a 372 basis-point spread of the U.S. high-yield health care sector in the Barclays indices, the metals and mining sector is nearing a distressed six-year high of 929 basis points.
“Mining companies face an outlook that may soon resemble the second quarter’s dire performance of the energy sector, where revenues plunged 33% as profits fell by 57%,” the economist said.
His conclusion? The persistently below-average high-yield credit spreads “of many solidly performing U.S. corporate sectors point to investor confidence in broad areas outside of raw materials.”
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