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By Ronald Fink
Although the stock and bond market rallies have reduced the near-term risk of default for non-investment grade corporate bond issuers, their underlying financials are not necessarily any more solid, according to an analysis by research firm CreditSights presented earlier this week.
The overall estimate of the likelihood of default by high-yield issuers tracked by CreditSights fell from more than 15 percent in late 2008 to less than 5 percent by late summer. The estimate is based on the firm's analysis of firm-specific measures such as leverage, profitability, liquidity, and equity performance and of macroeconomic factors such as swap spreads, equity returns and interest rates.
But the decline in these companies' default likelihood largely reflects the higher asset values and lower cost of capital that stem from the market rallies. In fact, the companies' leverage levels have come down only slightly, from total indebtedness of more than $325 billion in January to slightly less than $325 billion as of last July, according to CreditSights.
What's more, many of the junk bond issuers have avoided default simply by extending their debt maturities through stop-gap refinancing. The number of so-called distressed exchanges during the downturn far exceeds those in previous recessions, the analysis found. There were 23 such exchanges between January 2008 and April of this year, compared with only eight in both the downturn of 2001 to 2002 and of 1990 to 1991.
As a result, such companies are vulnerable to a stock or bond market downturn, said CreditSights analyst Kai Gilkes during a presentation of the research at a conference last Monday. If equity markets fell anywhere from 20 percent to 40 percent from current levels, or swap spreads widened by 30 basis points to 60 bps, for example, Gilkes estimated the likelihood of defaults by these companies would soar to more than 50 percent in 2010.
"What may prove to be the worst default cycle since the Great Depression may be slowing but is far from over," Gilkes observed.
The analyst said the risk of default at present is highest in the airline, media and cable, and paper and packaging industries.
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