Corporate & Sovereign
Credit Market Outlook
Dr. Edward Altman
NYU Stern School of Business
2014 Luncheon Conference
TMA, NY Chapter
New York
January 27, 2014
1 1
Summary of Recent High-Yield Bond
Activity & Outlook
•
Continued Low Default Rates and Bankruptcies (Chapter 11 Filings) and High Recovery Rates
Since 2010
- Outlook is for Default Rates in the U.S. H.Y. Market to Remain Below Average, but for European
Default Rates to Increase
- Decreasing Chapter 11 Filings and Time to Emergences since 2009
- Current Levels of Filings about Equal to Historic Median
•
Record New Issuance of H.Y. Bonds in the U.S. and Europe Since 2010
- Outlook is for Record or Near-Record Continued New Issuance as Interest Rates Remain at
Near Record Low Levels
- Increase in High-Yield New Issues at CCC Level Implying Higher Risk of Future Defaults
- Asian High-Yield Bond Market Size about 1/3 of Europe and Less than 1/10 of U.S. (but
Growing)
•
Credit Quality of U.S. H.Y. and I.G. Market Now No Better than, and Probably Worse than, Prior
to the Financial Crisis (2007)
- Z-Score Model Results
- Liquidity/Debt Comparisons
•
Moderate Risk-Adjusted Returns for High-Yield and Distressed Debt Markets, Despite Elevated
Price Levels
- Outlook is for Mid-High Single-Digit Returns in 2014
•
Quality Junk Strategy
- Buy Quality Junk and Sell Junk Quality
•
A Novel Approach To Assessing Sovereign Debt Default Risk
- Bottom-Up Approach for Private Firms and Banks in Europe and Asia
2
YTM & Option-Adjusted Spreads Between High
Yield Markets & U.S. Treasury Notes
June 01, 2007 – January 15, 2014
2,700
Yield Spread (YTMS)
OAS
Average YTMS (1981-2012)
Average OAS (1981-2012)
12/16/08 (YTMS = 2,046bp, OAS = 2,144bp)
2,200
1,700
1,200
700
6/12/07 (YTMS = 260bp, OAS = 249bp)
1/15/14 (YTMS = 346bp, OAS = 387bp)
6/1/2007
7/27/2007
9/21/2007
11/16/2007
1/15/2008
3/11/2008
5/6/2008
7/1/2008
8/26/2008
10/21/2008
12/16/2008
2/12/2009
4/9/2009
6/4/2009
7/30/2009
9/24/2009
11/19/2009
1/18/2010
3/15/2010
5/10/2010
7/5/2010
8/30/2010
10/25/2010
12/20/2010
2/14/2011
4/11/2011
6/6/2011
8/1/2011
9/26/2011
11/21/2011
1/18/2012
3/14/2012
5/9/2012
7/4/2012
8/29/2012
10/24/2012
12/19/2012
2/15/2013
4/12/2013
6/7/2013
8/2/2013
9/27/2013
11/22/2013
200
YTMS = 540bp, OAS = 545bp
Sources: Citigroup Yieldbook Index Data and Bank of America Merrill Lynch.
3
6/1/2007
7/27/2007
9/21/2007
11/16/2007
1/15/2008
3/11/2008
5/6/2008
7/1/2008
8/26/2008
10/21/2008
12/16/2008
2/12/2009
4/9/2009
6/4/2009
7/30/2009
9/24/2009
11/19/2009
1/18/2010
3/15/2010
5/10/2010
7/5/2010
8/30/2010
10/25/2010
12/20/2010
2/14/2011
4/11/2011
6/6/2011
8/1/2011
9/26/2011
11/21/2011
1/18/2012
3/14/2012
5/9/2012
7/4/2012
8/29/2012
10/24/2012
12/19/2012
2/15/2013
4/12/2013
6/7/2013
8/2/2013
9/27/2013
11/22/2013
High Yield Bonds - Yield to Maturity vs.
Yield to Worst
June 01, 2007 – January 15, 2014
25%
High
12/12/08 (YTM = 23.03%)
12/15/08 (YTW = 22.65%)
20%
15%
10%
1/15/14 (YTM = 6.34%)
1/15/14 (YTW = 5.44%)
5%
Low
5/09/13 (YTM = 6.03%)
5/09/13 (YTW = 4.99%)
0%
YTM
Sources: Citigroup Yieldbook Index Data
YTW
4
Major Risks Going Forward
(For 2014)
•
Global Economy Slowdown – Primarily U.S. (Double-Dip?): Impact on Default & Recovery Rates,
Credit Availability & Credit Quality
– China
– Europe
•
Sovereign Debt Crisis – Europe (Asia?)
– Calm in Late 2012-2013
– Looming Corporate Defaults Despite Low (2012) Default Rate?
– Survival of the Euro?
– Problems in India and Indonesia, Brazil?
•
Fed Balance Sheet, Money Supply and Inflation
•
LBO and Covenant-Lite Risk
•
Role of Collateral in the Global Financial System
•
Contagion Between Markets – Debt and Equity
•
Increased Investor Leverage in Stock Markets Similar to 2007
•
Political Paralysis – Deficit/Debt Levels
•
U.S. Municipal Bond & Federal Government Default Risk
•
Uncertainties (non-quantifiable)
5
Historical Default Rates and
Recession Periods in the U.S.
HIGH YIELD BOND MARKET (1972 – 2013 (Preliminary))*
14.0%
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
12
10
08
06
04
02
00
98
96
94
92
90
88
86
84
82
80
78
76
74
72
0.0%
Periods of Recession: 11/73 - 3/75, 1/80 - 7/80, 7/81 - 11/82, 7/90 - 3/91, 4/01 – 12/01, 12/07 - 6/09
*All rates annual
Source: E. Altman (NYU Salomon Center) & National Bureau of Economic Research
6
Historical Default Rates
Straight Bonds Only Excluding Defaulted Issues From Par Value Outstanding, (US$ millions)
1971 – 2013 (Preliminary)
a
Year
Par Value
Outstandinga ($)
Par Value
Defaults ($)
Default Rates
(%)
2013
1,392,212
14,539
1.044
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1,212,362
1,354,649
1,221,569
1,152,952
1,091,000
1,075,400
993,600
1,073,000
933,100
825,000
757,000
649,000
597,200
567,400
465,500
335,400
271,000
240,000
235,000
206,907
163,000
183,600
181,000
189,258
148,187
129,557
90,243
19,647
17,963
13,809
123,878
50,763
5,473
7,559
36,209
11,657
38,451
96,855
63,609
30,295
23,532
7,464
4,200
3,336
4,551
3,418
2,287
5,545
18,862
18,354
8,110
3,944
7,486
3,156
1.621
1.326
1.130
10.744
4.653
0.509
0.761
3.375
1.249
4.661
12.795
9.801
5.073
4.147
1.603
1.252
1.231
1.896
1.454
1.105
3.402
10.273
10.140
4.285
2.662
5.778
3.497
Weighted by par value of amount outstanding for each year.
Source: Author’s compilation and Citigroup/Credit Suisse estimates
Year
Par Value
Outstanding* ($)
Par Value
Defaults ($)
Default
Rates (%)
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
1975
1974
1973
1972
1971
58,088
40,939
27,492
18,109
17,115
14,935
10,356
8,946
8,157
7,735
7,471
10,894
7,824
6,928
6,602
992
0.840
1.095
3.186
0.158
1.500
0.193
1.330
4.671
0.388
2.731
1.129
0.626
2.786
1.242
1.708
0.840
1.095
3.186
0.158
1.500
0.193
1.330
4.671
0.388
2.731
1.129
0.626
2.786
1.242
Standard
Deviation (%)
Arithmetic Average Default Rate (%)
1971 to 2013
3.141
3.129
1978 to 2013
3.374
3.312
1985 to 2013
3.903
3.459
Weighted Average Default Rate (%)*
1971 to 2013
3.606
1978 to 2013
3.612
1985 to 2013
3.631
Median Annual Default Rate (%)
1971 to 2013
1.621
7
Default Rates on High-Yield Bonds
QUARTERLY DEFAULT RATE AND FOUR QUARTER MOVING AVERAGE
1989 – 2013 (Preliminary)
6.0%
16.0%
14.0%
5.0%
Quarterly Default Rate
4.0%
10.0%
3.0%
8.0%
6.0%
2.0%
4.0%
4 - Quarter Moving Average
12.0%
1.0%
2.0%
0.0%
0.0%
Quarterly
Source: Author’s Compilations
Moving
8
Trends in Bankruptcy Filings
Source: Edward I. Altman, “The Role of Distressed Debt Markets, Hedge Funds and Recent Trends in Bankruptcy
on the Outcomes of Chapter 11 Reorganizations”, ABI Law Review forthcoming December 2013
9
Filings for Chapter 11
Number of Filings and Pre-petition Liabilities of Filing Companies
1989 – 2013 (Preliminary)
Pre- Petition Liabilities, in $ billions (left axis)
Number of Filings (right axis)
$800
280
$700
240
$600
$ Billion
Median Liabilities
200
$500
160
$400
120
$300
$200
$100
$0
80
Median No. of Filings
2012
69 filings a nd
2012
lia bilities
of $71.6
billion
69 filings a nd
lia bilities
of $71.6
2012 (5/31)
billion
36 filings a nd
2013
lia bilities
of $46.7
billion
64 filings a nd
lia bilities
of $38.2
2013 (5/31)
billion
28 filings a nd
lia bilities of $16.9
billion
40
0
Mean 1989-2013: 75 filings
Median 1989-2013: 51 filings
Note: Minimum $100 million in liabilities
Source: NYU Salomon Center Bankruptcy Filings Database
10
Chapter 11 Filing Statistics
Year
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013 (Prelim)
Mean No. of Filings, 1989-2013
Median No. of Filings, 1989-2013
Median No. of Filings, 1998-2013
Mean Liabilities, 1989-2013
Median Liabilities, 1989-2013
Number of
Filings
Pre-Petition Liabilities
($ billions)
Number of Filings
≥ $1B
≥$1B/Total
Filings (%)
22
35
51
37
37
24
32
32
36
56
109
136
169
135
102
44
35
32
38
145
234
114
84
69
64
75
51
93
33,539
41,115
81,158
64,224
17,701
8,396
27,153
11,687
18,866
32,038
70,957
98,896
228,604
336,612
115,172
39,550
142,625
22,322
72,646
724,010
603,992
56,981
109,119
71,613
38,157
10
10
11
14
4
1
7
0
5
6
19
23
38
41
26
11
11
4
8
24
50
14
7
14
10
15
11
14
45
29
22
38
11
4
22
0
14
11
17
17
22
30
25
25
31
13
21
17
21
12
8
20
16
20%
20%
122,685
64,224
Note: Minimum $100 million in liabilities. Source: NYU Salomon Center Bankruptcy Filings Database
11
Chapter 11 Filings-Sample Characteristics
1981-2013
(6/30)
12
Successful vs Unsuccessful Chapter 11s
• Successful Chapter 11
– Emergence from Chapter 11
– Acquired in Chapter 11
• Unsuccessful Chapter 11
– Conversion into Chapter 7
– Liquidated under Chapter 11
• Adjustments made for Chapter 22,33,44
13
Success vs. Nonsuccess in Chapter 11 Reorganizations
(Based on known outcomes)
Adjustment For Recidivism
All Filings
(Chapter 22, 33, 44)
(3013)
Assets > $100 million
(1575)
Assets > $500 million
(613)
Success vs. Nonsuccess in Chapter 11 Reorganizations
(Based on known outcomes, no adjustments for recidivism)
1981-2013
All Filings
(3013) (592)
Assets > $100 million
(1575) (361)
Assets > $500 million
(613) (154)
2006-2010
Prepacks/Prearranged vs Non-Prepacks among Non-Dismissed Filings
1981-2013
All Filings
2006-2013
Assets > $100 million
Assets > $500 million
17
18
19
20
21
22
New Issuance: U.S. High Yield Bond Market
2005 – 2013
Annual
Ratings
Total
BB
B
CCC
(% H.Y.)
NR
2005
81,541.8
18,615.0
45,941.2
15,750.9
(19.3%)
1,234.7
2006
131,915.9
37,761.2
67,377.3
25,319.2
(19.2%)
1,458.2
2007
132,689.1
23,713.2
55,830.8
49,627.6
(37.4%)
3,517.5
2008
50,747.2
12,165.0
25,093.1
11,034.4
(21.7%)
2,454.6
2009
127,419.3
54,273.5
62,277.4
10,248.4
(8.0%)
620.0
2010
229,307.4
74,189.9
116,854.7
35,046.8
(15.3%)
3,216.1
2011 (1Q)
68,600.3
10,266.0
45,342.5
10,145.0
(14.8%)
2,846.8
(2Q)
62,846.7
16,492.7
38,849.0
7,505.0
(11.9%)
0.0
(3Q)
22,853.9
10,650.0
9,568.9
2,460.0
(10.8%)
175.0
(4Q)
30,270.0
17,125.0
11,880.0
1,265.0
(4.2%)
0.0
184,571.0
54,533.8
105,640.4
21,375.0
(11.6%)
3,021.8
2012 (1Q)
75,462.0
26,071.1
36,003.0
11,362.9
(15.1%)
2,025.0
(2Q)
40,748.9
9,589.2
21,724.5
6,583.1
(16.2%)
2,852.0
(3Q)
86,806.5
23,529.1
46,640.0
16,092.4
(18.5%)
545.0
(4Q)
77,432.9
12,662.7
49,243.5
14,651.7
(18.9%)
875.0
280,450.3
71,852.1
153,611.1
48,690.2
(17.4%)
6,297.0
2013 (1Q)
73,492.3
31,953.1
29,534.2
11,480.0
(15.6%)
525.0
(2Q)
62,135.0
24,380.0
23,665.0
13,790.0
(22.2%)
300.0
(3Q)
73,770.8
22,964.2
32,610.0
18,196.6
(24.7%)
0.0
(4Q)
60,936.8
24,050.0
22,686.8
14,175.0
(23.3%)
25.0
270,334.8
103,347.3
108,495.9
57,641.6
(21.3%)
850.0
2011 Totals
2012 Totals
Source: Bank
of America
Merrill Lynch
($ millions)
2013 Totals
23
New Issuance: European High Yield Bond Market
Face Values (US$)
2005 – 2013
Annual
Source:
BoAML
Ratings
Total
BB
B
CCC
NR
USD
EUR
GBP
2005
19,935.6
1,563.3
11,901.0
5,936.6
534.8
2,861.0
15,080.3
1,668.3
2006
27,714.6
5,696.2
16,292.1
5,020.5
705.9
7,657.8
19,935.7
121.1
2007
18,796.7
5,935.3
11,378.5
562.0
920.9
4,785.5
12,120.9
1,890.3
2008
1,250.0
1,250.0
25,093.1
2009
41,510.3
18,489.4
16,697.4
4,771.3
1,552.2
12,315.0
28,696.9
498.3
2010
57,636.5
22,751.3
29,050.5
2,170.7
3,663.9
12,775.0
43,147.7
1,403.3
2011 (1Q)
25,750.6
9,272.6
14,610.6
1,867.5
7,775.0
14,215.0
3,191.3
(2Q)
27,636.1
9,682.6
14,516.6
1,845.3
7,645.0
14,045.7
5,651.1
(3Q)
4,211.2
3,418.7
792.5
(4Q)
2,838.0
2,355.0
2011 Totals
60,435.8
24,728.9
2012 (1Q)
21,788.3
(2Q)
1,250.0
1,591.5
4,211.2
395.9
87.0
1,300.0
1,286.1
29,919.7
4,108.7
1,678.6
16,720.0
33,758.0
8,842.4
8,904.1
11,003.0
1,734.6
146.6
8,945.0
10,783.0
1,108.2
9,075.8
2,086.4
6,296.0
693.4
4,080.0
4,179.3
816.5
(3Q)
17,733.2
9,138.4
4,122.4
2,652.5
1,820.0
6,350.0
10,399.2
241.2
(4Q)
16,918.8
6,872.9
7,591.7
2,106.2
348.0
8,823.0
6,908.8
763.5
2012 Totals
65,516.1
27,001.7
29,013.0
7,186.7
2,314.6
28,198.0
32,270.4
2,929.3
2013 (1Q)
27,954.5
6,783.8
15,008.4
5,160.6
1,001.7
10,050.0
12,380.7
4,837.4
(2Q)
30,335.3
6,860.2
19,295.1
3,724.1
455.9
9,913.0
14,149.9
6,074.0
(3Q)
16,558.4
3,375.3
9,609.6
2,721.8
851.7
5,310.0
8,644.0
2,604.4
(4Q)
16,520.4
2,588.0
10,522.1
2,366.4
1,043.9
5,210.0
8,951.0
2,359.4
24
91,368.6
19,607.3
54,435.2
13,972.9
3,353.2
30,483.0
44,125.6
15,875.3
2013 Totals
Size of the US High-Yield Bond Market
1978 – 2013 (Mid-year US$ billions)
$1,392
25
Size of Western European HY Market
(€ Billions)
400
Non-$US Mkt Size
368.9
$US Mkt Size
Market Size €Billions
350
300
282.8
250
276
193.7
200
207
154.4
150
143
108.4
100
69.6
45.3
50
0
1.7 5.4
5
2
8.8
9
13.6 27.0
6
21
12
15
30
61.1
88.9 84.2
41
25
33
36
37
48
81.4
114
79.0 80.1 76.6 81.3
78
57
27
59
22
61
60
61
58
18
20
15
23
30
40
51
76
93
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Includes non-investment grade straight corporate debt of issuers with assets located in or revenues derived from Western Europe, or
the bond is denominated in a Western European currency. Floating-rate and convertible bonds and preferred stock are not included.
Source: Credit Suisse
26
Size of Corporate HY Bond Market: U.S., Europe,
Latin America & Asia (ex. Japan) ($ Billions)
2013
LatAm
Asia
Europe
U.S.
111
114
340
1,400
0
200
400
600
800
1,000
1,200
1,400
1,600
$ Billions
Source: NYU Salomon Center, Credit Suisse, LIM Advisors Ltd.
27
Stronger Investment Grade
and/or High-Yield Firm
Balance Sheets?
28
Z-Score Component Definitions
and Weightings
Variable
X1
Definition
Weighting Factor
Working Capital
1.2
Total Assets
X2
Retained Earnings
1.4
Total Assets
X3
EBIT
3.3
Total Assets
X4
Market Value of Equity
0.6
Book Value of Total Liabilities
X5
Sales
Total Assets
1.0
29
Z” Score Model for Manufacturers,
Non-Manufacturer Industrials; Developed and
Emerging Market Credits
Z” = 6.56X1 + 3.26X2 + 6.72X3 + 1.05X4 +3.25
X1 = Current Assets - Current Liabilities
Total Assets
X2 =
Retained Earnings
Total Assets
X3 = Earnings Before Interest and Taxes
Total Assets
X4 =
Book Value of Equity
Total Liabilities
30
Comparing Financial Strength of High-Yield
Bond Issuers in 2007& 2012
Number of Firms
Z-Score
Z”-Score
2007
277
383
2012
404
488
Year
Average Z-Score/
(BRE)*
Median Z-Score/
(BRE)*
Average Z”-Score/
(BRE)*
Median Z”-Score/
(BRE)*
2007
1.89 (B)
1.81 (B)
4.58 (B+)
4.61 (B+)
2012
1.66 (B)
1.59 (B)
4.60 (B+)
4.60 (B+)
Difference in Means Test (2007 vs 2012)
Model
Average
Difference
Standard Deviation
(2007/2012)
t-test
Significance
Level
Significant at
.05?
Z-Score
-0.23
1.29 / 1.15
-2.38
0.88%
Yes
Z”-Score
+0.02
2.50 / 2.07
+0.13
44.68%
No
*Bond Rating Equivalent
Source: Authors’ calculations, data from Altman and Hotchkiss (2006) and S&P Capital IQ.
31
Comparing Financial Strength of Investment
Grade Bond Issuers in 2007& 2012
Number of Firms
Z-Score
Z”-Score
2007
324
349
2012
432
457
Year
Average Z-Score/
(BRE)*
Median Z-Score/
(BRE)*
Average Z”-Score/
(BRE)*
Median Z”-Score/
(BRE)*
2007
2.84 (BBB)
2.59 (BB+)
5.60 (BBB-)
5.56 (BBB-)
2012
2.60 (BB+)
2.36 (BB)
5.64 (BBB-)
5.65 (BBB-)
Difference in Means Test (2007 vs 2012)
Model
Average
Difference
Standard Deviation
(2007/2012)
t-test
Significance
Level
Significant at
.05?
Z-Score
-0.24
1.86 / 1.61
-1.80
3.59%
Yes
Z”-Score
+0.04
2.51 / 2.17
+0.22
41.43%
No
*Bond Rating Equivalent
Source: Authors’ calculations, data from Altman and Hotchkiss (2006) and S&P Capital IQ.
32
Average Z-Score by S&P Bond Rating
Rating
Average Z-Score
Standard Deviation
AAA
6.2
2.1
AA
4.7
2.4
A
3.7
2.3
BBB
2.8
1.5
BB
2.4
1.9
B
1.8
1.9
CCC
0.3
1.2
D
-0.2
2.5
Source: E. Altman and E. Hotchkiss (2006), Corporate Financial Distress and Bankruptcy, John Wiley & Sons, pp.247/248.
33
Average Z”-Score by S&P Bond Rating
Rating
Average Z”-Score
Rating
Average Z”-Score
AAA
8.15
BB+
5.25
AA+
7.60
BB
4.95
AA
7.30
BB-
4.75
AA-
7.00
B+
4.50
A+
6.85
B
4.15
A
6.65
B-
3.75
A-
6.40
CCC+
3.20
BBB+
6.25
CCC
2.50
BBB
5.85
CCC-
1.75
BBB-
5.65
D
0.00
Source: E. Altman and E. Hotchkiss (2006), Corporate Financial Distress and Bankruptcy, John Wiley & Sons, pp.247/248.
34
Comparing Measures of Liquidity, Solvency, Profitability
and Leverage of High-Yield Bond Firms, 2007 versus 2012
Ratio
Average 2007
Average 2012
Change
Significant at .05
0.10
0.11
+0.01
No
0.21
0.21
-0.00
No
0.24
0.25
+0.01
No
-0.08
-0.10
-0.02
No
0.07
0.07
+0.00
No
2.68
2.94
+0.25
No
1.16
1.00
-0.16
Yes
0.47
0.47
+0.00
No
Current Assets – Current Liabilities
Total Assets
Cash & Equivalents
Total Debt
Cash & Equiv & S.T. Inv.
Total Debt
Retained Earnings
Total Assets
EBIT
Total Assets
EBIT
Cash Interest
Market Value Equity
Total Liabilities
Book Value Equity
Total Liabilities
35
Source: Authors’ calculations, data from S&P Capital IQ.
Comparing Measures of Liquidity, Solvency, Profitability
and Leverage of Investment Grade Bond Firms, 2007
versus 2012
Ratio
Average 2007
Average 2012
Average Change
Significant at .05
0.05
0.07
+0.02
Yes
0.30
0.36
+0.06
Yes
0.12
0.19
+0.07
Yes
0.16
0.12
-0.04
Yes
0.11
0.10
-0.01
No
6.33
6.73
+0.40
No
2.23
2.00
-0.23
No
0.74
0.81
+0.07
No
Current Assets – Current Liabilities
Total Assets
Cash & Equivalents
Total Debt
Cash & Equiv & S.T. Inv.
Total Debt
Retained Earnings
Total Assets
EBIT
Total Assets
EBIT
Cash Interest
Market Value Equity
Total Liabilities
Book Value Equity
Total Liabilities
36
Source: Authors’ calculations, data from S&P Capital IQ.
Major Risks Going Forward
(For 2014)
•
Global Economy Slowdown – Primarily U.S. (Double-Dip?): Impact on Default & Recovery Rates,
Credit Availability & Credit Quality
– China
– Europe
•
Sovereign Debt Crisis – Europe (Asia?)
– Calm in Late 2012-2013
– Looming Corporate Defaults Despite Low (2012) Default Rate?
– Survival of the Euro?
– Problems in India and Indonesia, Brazil?
•
Fed Balance Sheet, Money Supply and Inflation
•
LBO and Covenant-Lite Risk
•
Role of Collateral in the Global Financial System
•
Contagion Between Markets – Debt and Equity
•
Increased Investor Leverage in Stock Markets Similar to 2007
•
Political Paralysis – Deficit/Debt Levels
•
U.S. Municipal Bond & Federal Government Default Risk
•
Uncertainties (non-quantifiable)
37
A Novel Approach to
Assessing Sovereign Debt
Default Risk
Euro High-Yield Option-Adjusted Spreads
June 01, 2007 – January 15, 2014
OAS
Average OAS (1998-2013)
2650
12/18/08 (OAS = 2,326bp)
2150
1650
1150
Average OAS = 711bp
650
150
6/1/2007
1/15/14 (OAS = 350bp)
6/05/07 (OAS = 182bp)
6/1/2008
6/1/2009
Sources: Bank of America Merrill Lynch Index Data.
6/1/2010
6/1/2011
6/1/2012
6/1/2013
39
Five Year Implied Probabilities of Default (PD) From
Capital Market CDS Spreads*
Jan. 2009 – January 15, 2014
100
Greece (9/16/11)
94.75
90
Default Probability (As %)
80
70
60
50
Portugal
20.58
40
30
20
Italy 11.57
Spain 9.92
10
*Assuming
Italy
Greece
Portugal
a 40% recovery rate (R); based on the median CDS spread (s). PD Computed as 1-e(-5*s/(1-R)).
Source: Bloomberg
4-Jan-14
4-Nov-13
4-Jul-13
4-May-13
4-Mar-13
4-Jan-13
4-Nov-12
4-Sep-12
4-Jul-12
4-May-12
4-Mar-12
4-Jan-12
4-Nov-11
4-Sep-11
4-Jul-11
4-May-11
4-Mar-11
4-Jan-11
4-Nov-10
4-Sep-10
4-Jul-10
4-May-10
4-Mar-10
4-Jan-10
4-Nov-09
4-Sep-09
4-Jul-09
4-May-09
4-Mar-09
4-Jan-09
Spain
4-Sep-13
Ireland 8.65
0
Ireland
40
European (PIIGS) Government
Benchmark Yields and Spreads
January 15, 2014
Country
5-Year
Price
5-Year
Yield %
5-Year
Spread to
Germany
Germany
100.39
0.92
n/a
101.53
1.82
n/a
Greece
n/a
n/a
n/a
70.94
7.67
5.85
Ireland
112.11
1.81
0.89
99.14
3.50
1.68
Italy
104.97
2.42
1.50
105.63
3.86*
2.04
Portugal
101.99
4.32
3.40
102.72
5.30
3.48
Spain
106.66
2.26
1.34
105.16
3.76*
1.94
*10-Year Yield as of July 16, 2012 was 6.10% for Italy and 6.77% for Spain.
Source: Bloomberg
10-Year
Price
10-Year
Yield %
10-Year
Spread to
Germany
41
Sovereign Ratings Actions (Moody’s)
2009 - Present
Greece
Ratings
A1
A2
A3
Ba1
Downgraded to SD
by S&P, Dec. 2012
B1
Caa1
Ca
Caa3
C
42
Sovereign Ratings Actions (Moody’s)
2009 - Present
Portugal
Ratings
Aa2
A1
A3
Baa1
Ba2
Ba3
43
Sovereign Ratings Actions (Moody’s)
2009 - Present
Ireland
AAA
Aa1
Aa2
Ratings
Baa1
Baa3
Ba1
44
Sovereign Ratings Actions (Moody’s)
2009 - Present
Spain
Ratings
AAA
Aa1
Aa2
A1
A3
Baa3
45
Sovereign Ratings Actions (Moody’s)
2009 - Present
Italy
Aa2
A2
A3
Ratings
Baa2
46
Financial Health of the Corporate, Non-Financial Sector: Selected
European Countries and Australia/U.S.A.in 2008-2013 (6/30)
(Z-Metrics PD Estimates – 75th Percentile)
Z-Metrics PD Estimates*: Five-Year Public Model
Country
Listed
Companies
(2013)**
6/30/13
Y/E 2012
Y/E 2011
Y/E 2010
Y/E 2009
Y/E 2008
Sweden
172
11.5%
7.4%
9.6%
6.8%
8.0%
13.5%
Netherlands
78
9.7%
5.7%
8.7%
5.7%
6.7%
15.7%
U.K.
515
6.0%
5.9%
9.7%
5.7%
9.3%
16.6%
Spain
92
27.0%
21.7%
20.1%
13.2%
12.7%
18.4%
France
353
11.1%
9.6%
14.8%
8.5%
10.3%
19.2%
Germany
370
14.5%
10.1%
11.2%
9.7%
11.9%
22.2%
Portugal
34
41.6%
38.8%
24.9%
20.1%
12.3%
26.6%
Italy
168
22.3%
22.3%
26.4%
14.1%
18.1%
27.1%
Ireland
24
3.9%
3.5%
6.3%
8.6%
11.0%
27.5%
Greece
97
64.0%
59.0%
50.5%
40.1%
27.6%
31.0%
Australia
359
10.7%
10.6%
11.0%
6.2%
7.8%
16.3%
2,450
4.0%
4.6%
11.7%
8.0%
11.5%
19.5%
U.S.A.
*Since
75th Percentile PD
the Z-Metrics Model is not practically available for most analysts, we could substitute the Z”-Score method (available from
<altmanZscoreplus.com>). **Sales > € 50mm
Sources: RiskMetrics Group (MSCI), Markit, Compustat.
47
Weighted Average Median 5-Year PD for Listed Non-Financial1
and Banking Firms2 (Europe & US): 2010
Non-Financial Firms
Banking Firms
PD (%)
Weight
PD (%)
Weight
Weighted
Average (%)
Rank
CDS Spread
PD (%)
Rank
Netherlands
2.5
0.977
11.1
0.023
2.70
1
2.03
1
Sweden
2.6
0.984
17.3
0.016
2.84
2
2.25
2
U.K.
3.7
0.977
15.5
0.023
3.97
3
4.73
6
Germany
3.9
0.983
13.1
0.017
4.06
4
2.50
3
France
4.0
0.986
14.0
0.014
4.14
5
4.51
5
U.S.A.
3.8
0.837
13.8
0.163
5.43
6
3.79
4
Spain
7.1
0.948
10.9
0.052
7.30
7
25.27
8
Italy
7.7
0.906
20.0
0.094
8.86
8
18.02
7
Portugal
9.9
0.971
12.1
0.029
9.96
9
34.05
9
Greece
18.7
0.921
30.1
0.079
19.60
10
59.14
10
Country
1
Based on Z-Metrics Default Probability Model.
2 Based on Altman-Rijken Model (Preliminary)
48
Five Year Implied Probabilities of Default (PD) From
Sovereign CDS* Spreads vs 75th Percentile Corporate PD
Greece, 2008 – 2013 (1H)
100.00%
Default Probability (As %)
90.00%
80.00%
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
75th Percentile
*Assuming
1H 2013
2012
2011
2010
2009
2008
0.00%
CDS
a 40% recovery rate (R); based on the median CDS spread (s). PD Computed as 1-e(-5*s/(1-R)).
Source: Bloomberg
49
Five Year Implied Probabilities of Default (PD) From
Sovereign CDS* Spreads vs 75th Percentile Corporate PD
Portugal, 2008 – 2013
70.00%
Default Probability (As %)
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
75th Percentile
*Assuming
2013
1H 2013
2012
2011
2010
2009
2008
0.00%
CDS
a 40% recovery rate (R); based on the median CDS spread (s). PD Computed as 1-e(-5*s/(1-R)).
Source: Bloomberg
50
Five Year Implied Probabilities of Default (PD) From
Sovereign CDS* Spreads vs 75th Percentile Corporate PD
Italy, 2008 – 2013
40.00%
Default Probability (As %)
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
75th Percentile
*Assuming
2013
1H 2013
2012
2011
2010
2009
2008
0.00%
CDS
a 40% recovery rate (R); based on the median CDS spread (s). PD Computed as 1-e(-5*s/(1-R)).
Source: Bloomberg
51
Five Year Implied Probabilities of Default (PD) From
Sovereign CDS* Spreads vs 75th Percentile Corporate PD
Spain, 2008 – 2013
Default Probability (As %)
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
75th Percentile
*Assuming
2013
1H 2013
2012
2011
2010
2009
2008
0.00%
CDS
a 40% recovery rate (R); based on the median CDS spread (s). PD Computed as 1-e(-5*s/(1-R)).
Source: Bloomberg
52
Five Year Implied Probabilities of Default (PD) From
Sovereign CDS* Spreads vs 75th Percentile Corporate PD
Ireland, 2008 – 2013
50.00%
Default Probability (As %)
45.00%
40.00%
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
75th Percentile
*Assuming
2013
1H 2013
2012
2011
2010
2009
2008
0.00%
CDS
a 40% recovery rate (R); based on the median CDS spread (s). PD Computed as 1-e(-5*s/(1-R)).
Source: Bloomberg
53
Five Year Implied Probabilities of Default (PD) From
Sovereign CDS* Spreads vs 75th Percentile Corporate PD
France, 2008 – 2013 (1H)
Default Probability (As %)
25.00%
20.00%
15.00%
10.00%
5.00%
75th Percentile
*Assuming
1H 2013
2012
2011
2010
2009
2008
0.00%
CDS
a 40% recovery rate (R); based on the median CDS spread (s). PD Computed as 1-e(-5*s/(1-R)).
Source: Bloomberg
54
Five Year Implied Probabilities of Default (PD) From
Sovereign CDS* Spreads vs 75th Percentile Corporate PD
Germany, 2008 – 2013 (1H)
Default Probability (As %)
25.00%
20.00%
15.00%
10.00%
5.00%
75th Percentile
*Assuming
1H 2013
2012
2011
2010
2009
2008
0.00%
CDS
a 40% recovery rate (R); based on the median CDS spread (s). PD Computed as 1-e(-5*s/(1-R)).
Source: Bloomberg
55
ASIA ANALYSIS
Financial Health of the Corporate, Non-Financial
Sector: Selected Asian & BRIC Countries
(Z-Metrics PD Estimates – 75th Percentile)
Z-Metrics PD Estimates*: Five-Year Public Model
Listed
Companies
(2013)**
1H 2013
Rank
Y/E 2012
1H 2012
Late 1990’s
Rank
2,462
7.5%
1
7.0%
8.7%
5.8%
2
Malaysia
367
9.4%
2
9.6%
9.3%
4.0%
1
Russia
126
10.2%
3
9.6%
9.5%
26.6%
9
Hong Kong
241
11.1%
4
11.6%
12.8%
8.5%
5
1,728
12.2%
5
12.0%
9.7%
10.6%
6
Singapore
323
13.1%
6
10.7%
11.2%
7.7%
4
Indonesia
211
14.3%
7
12.8%
8.8%
18.5%
7
India
522
14.9%
8
16.6%
10.6%
20.3%
8
South Korea
869
18.1%
9
15.6%
19.0%
29.0%
10
Brazil
200
23.5%
10
17.3%
20.0%
7.6%
3
Country
Japan
China
*Since
75th Percentile PD
the Z-Metrics Model is not practically available for most analysts, we could substitute the Z”-Score method (available from
<altmanZscoreplus.com>). **Sales > € 50mm
Sources: RiskMetrics Group (MSCI), Markit, Compustat.
57
Measures of Sovereign Financial Health: Selected
Asian Countries 75th Percentile 5-Year PD*
Financial Crisis of the late 1990’s to 2013 (1H)
70%
60%
50%
40%
30%
20%
KOR
IDN
10%
0%
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
(1H) (1H)
Indonesia
Japan
Source: Compustat (S&P), *Based on Z-Metrics Model Calculation
S. Korea
Malaysia
58
Measures of Sovereign Financial Health: BIRCHS
Countries 75th Percentile 5-Year PD*
Financial Crisis of the late 1990’s to 2013 (1H)
40%
35%
30%
25%
BRA
20%
IND
15%
10%
5%
0%
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
(1H) (1H)
Brazil
China
Hong Kong
Source: Compustat (S&P), *Based on Z-Metrics Model Calculation
India
Russia
Singapore
59
Five Year Implied Probabilities of Default (PD) From
CDS* Spreads vs 75th Percentile Corporate PD
India, 2008 – 2013 (10/25)
Default Probability (As %)
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
75th Percentile
*State
3Q 2013
1H 2013
2012
2011
2010
2009
2008
0.00%
CDS
Bank of India. Assuming a 40% recovery rate (R); based on the median CDS spread (s). PD Computed as 1-e(-5*s/(1-R)).
Source: Bloomberg
60
Five Year Implied Probabilities of Default (PD) From
Sovereign CDS* Spreads vs 75th Percentile Corporate PD
Indonesia, 2008 – 2013 (10/25)
50.00%
Default Probability (As %)
45.00%
40.00%
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
75th Percentile
*Assuming
3Q 2013
1H 2013
2012
2011
2010
2009
2008
0.00%
CDS
a 40% recovery rate (R); based on the median CDS spread (s). PD Computed as 1-e(-5*s/(1-R)).
Source: Bloomberg
61
Five Year Implied Probabilities of Default (PD) From
Sovereign CDS* Spreads vs 75th Percentile Corporate PD
S. Korea, 2008 – 2013 (10/25)
40.00%
Default Probability (As %)
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
75th Percentile
*Assuming
3Q 2013
1H 2013
2012
2011
2010
2009
2008
0.00%
CDS
a 40% recovery rate (R); based on the median CDS spread (s). PD Computed as 1-e(-5*s/(1-R)).
Source: Bloomberg
62
Five Year Implied Probabilities of Default (PD) From
Sovereign CDS* Spreads vs 75th Percentile Corporate PD
China, 2008 – 2013 (10/25)
Default Probability (As %)
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
75th Percentile
*Assuming
3Q 2013
1H 2013
2012
2011
2010
2009
2008
0.00%
CDS
a 40% recovery rate (R); based on the median CDS spread (s). PD Computed as 1-e(-5*s/(1-R)).
Source: Bloomberg
63
Major Risks Going Forward
(For 2014)
•
Global Economy Slowdown – Primarily U.S. (Double-Dip?): Impact on Default & Recovery Rates,
Credit Availability & Credit Quality
– China
– Europe
•
Sovereign Debt Crisis – Europe (Asia?)
– Calm in Late 2012-2013
– Looming Corporate Defaults Despite Low (2012) Default Rate?
– Survival of the Euro?
– Problems in India and Indonesia, Brazil?
•
Fed Balance Sheet, Money Supply and Inflation
•
LBO and Covenant-Lite Risk
•
Role of Collateral in the Global Financial System
•
Contagion Between Markets – Debt and Equity
•
Increased Investor Leverage in Stock Markets Similar to 2007
•
Political Paralysis – Deficit/Debt Levels
•
U.S. Municipal Bond & Federal Government Default Risk
•
Uncertainties (non-quantifiable)
64
Purchase Price Multiples
Purchase Price Multiple excluding Fees for LBO Transactions
12x
9.9
10x
9.5
9.1
8.88.7
8.4
8x
7.4
8.3
8.1
7.5
8.8
8.9
8.2
8.18.0
8.7
8.5
9.0
8.8
7.8
7.47.3
6.9
6.76.7
6.2
6.7
6.3
7.0
6.8
6x
5.2
4x
2x
N/A
0x
(# obs.) 1998
(90)
1999
(133)
2000
(116)
2001
(51)
2002
(40)
2003
(66)
2004
(127)
2005
(134)
2006 2007
(178) (207)
Public-to-Private
Source: S&P Capital IQ LCD
2008
(69)
2009
(23)
2010
(78)
2011
(87)
2012
(97)
2013
(95)
4Q13
(23)
All Other
65
Average Total Debt Leverage Ratio for LBO’s:
Europe and US with EBITDA of €/$50M or More
7.0x
6.6
6.2
5.8
6.0x
5.5
5.0x
4.7
4.9
4.4
4.3
4.5
4.4
4.3
4.1
4.1
2001
2002
4.7
4.8
5.4
5.5
5.3
4.9
4.9
4.6
4.5
4.7
5.4
5.3
5.2
4.9
4.8
4.5
4.0
4.0x
3.0x
2.0x
1.0x
0.0x
1999
2000
2003
2004
2005
Europe
Source: S&P Capital IQ LCD
2006
2007
2008
2009
2010
2011
2012
2013
US
66
Default Rate
Forecasting
67
Method 1:
Mortality Approach
68
New Issues Rated B- or Below, Based on the
Dollar Amount of Issuance
(1993 – 2013)
70.00%
60.00%
51.25%
50.00%
40.75%
39.06%
40.00%
33.00%
32.97%
30.41%
29.55%
33.57%
27.27%
30.00%
23.35%
18.16%
26.73%
21.48%
21.38%
19.40%
20.00%
31.56%
29.62%
28.12%
14.02%
13.73%
14.16%
10.00%
0.00%
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Source: S&P Capital IQ LCD
69
Marginal and Cumulative
Mortality Rate Equation
Total value of defaulting debt in year (t)
MMR(t) =
total value of the population at the start of the year (t)
MMR = Marginal Mortality Rate
One can measure the cumulative mortality rate (CMR) over a
specific time period (1,2,…, T years) by subtracting the product of
the surviving populations of each of the previous years from one
(1.0), that is,
CMR(t) = 1 -  SR(t) ,
t=1
here
CMR (t) = Cumulative Mortality Rate in (t),
SR (t) = Survival Rate in (t) , 1 - MMR (t)
70
Default Lag After Issuance: ‘B’ & ‘CCC’ Rated Corporate Bonds
Default Lag after Issuance for ‘B’
Default Lag after Issuance for ‘CCC’
Ratings
Ratings
20.0%
9.0%
7.84% 7.95%
8.0%
16.0%
6.0%
Default Rate
7.0%
Default Rate
18.15%
16.40%
18.0%
7.90%
5.81%
5.0%
4.53%
4.0%
3.64%
3.0%
2.94%
2.13%
2.0%
1.0%
1.80%
0.79%
0.0%
1
2
3
4
5
6
7
Years after Issuance
Source: Altman Mortality Tables (1971-2012)
8
9
10
14.0%
12.55%
12.0%
11.70%
10.0%
8.25%
8.0%
6.0%
5.44% 4.91%
4.75%
4.0%
2.0%
4.36%
0.72%
0.0%
1
2
3
4
5
6
7
8
9
10
Years after Issuance
Source: Altman Mortality Tables (1971-2012)
71
Mortality Rates by Original Rating
All Rated Corporate Bonds*
1971-2013 (Preliminary)
Years After Issuance
1
2
3
4
5
6
7
8
9
10
AAA Marginal
Cumulative
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.01%
0.01%
0.02%
0.03%
0.01%
0.04%
0.00%
0.04%
0.00%
0.04%
0.00%
0.04%
AA
Marginal
Cumulative
0.00%
0.00%
0.00%
0.00%
0.23%
0.23%
0.09%
0.32%
0.02%
0.34%
0.01%
0.35%
0.01%
0.36%
0.01%
0.37%
0.02%
0.39%
0.01%
0.40%
A
Marginal
Cumulative
0.01%
0.01%
0.04%
0.05%
0.14%
0.19%
0.15%
0.34%
0.12%
0.46%
0.08%
0.54%
0.02%
0.56%
0.27%
0.83%
0.09%
0.92%
0.06%
0.98%
BBB Marginal
Cumulative
0.35%
0.35%
2.40%
2.74%
1.30%
4.01%
1.02%
4.99%
0.52%
5.48%
0.25%
5.72%
0.28%
5.98%
0.16%
6.13%
0.16%
6.28%
0.34%
6.60%
BB
Marginal
Cumulative
0.96%
0.96%
2.05%
2.99%
3.92%
6.79%
1.98%
8.64%
2.35%
10.79%
1.50%
12.12%
1.48%
13.42%
1.13%
14.40%
1.47%
15.66%
3.16%
18.33%
B
Marginal
Cumulative
2.88%
2.88%
7.75%
10.41%
7.88%
17.47%
7.82%
23.92%
5.72%
28.27%
4.48%
31.49%
3.58%
33.94%
2.10%
35.33%
1.78%
36.48%
0.78%
36.97%
CCC Marginal
Cumulative
8.20%
8.20%
12.45%
19.63%
17.95%
34.06%
16.30%
44.80%
4.70%
47.40%
11.55%
53.47%
5.40%
55.99%
4.86%
58.13%
0.70%
58.42%
4.32%
60.22%
*Rated by S&P at Issuance
Based on 2,779 issues
Source: Standard & Poor's (New York) and Author's Compilation
72
Mortality Losses by Original Rating
All Rated Corporate Bonds*
1971-2013 (Preliminary)
Years After Issuance
1
2
3
4
5
6
7
8
9
10
AAA
Marginal
Cumulative
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.01%
0.01%
0.01%
0.02%
0.01%
0.03%
0.00%
0.03%
0.00%
0.03%
0.00%
0.03%
AA
Marginal
Cumulative
0.00%
0.00%
0.00%
0.00%
0.03%
0.03%
0.03%
0.06%
0.01%
0.07%
0.01%
0.08%
0.00%
0.08%
0.01%
0.09%
0.01%
0.10%
0.01%
0.11%
A
Marginal
Cumulative
0.00%
0.00%
0.02%
0.02%
0.06%
0.08%
0.07%
0.15%
0.07%
0.22%
0.04%
0.26%
0.02%
0.28%
0.03%
0.31%
0.06%
0.37%
0.03%
0.40%
BBB
Marginal
Cumulative
0.25%
0.25%
1.56%
1.81%
0.78%
2.57%
0.60%
3.16%
0.28%
3.43%
0.15%
3.57%
0.17%
3.74%
0.10%
3.83%
0.10%
3.93%
0.19%
4.11%
BB
Marginal
Cumulative
0.57%
0.57%
1.19%
1.75%
2.33%
4.04%
1.13%
5.13%
1.34%
6.40%
0.72%
7.07%
0.80%
7.82%
0.50%
8.28%
0.76%
8.97%
1.12%
9.99%
B
Marginal
Cumulative
1.93%
1.93%
5.42%
7.25%
5.35%
12.21%
5.23%
16.80%
3.78%
19.94%
2.46%
21.91%
2.33%
23.73%
1.16%
24.62%
0.93%
25.32%
0.54%
25.72%
CCC
Marginal
Cumulative
5.41%
5.41%
8.71%
13.65%
12.56%
24.49%
11.48%
33.16%
3.33%
35.39%
8.66%
40.98%
4.05%
43.37%
3.40%
45.30%
0.43%
45.53%
2.76%
47.04%
*Rated by S&P at Issuance
Based on 2,290 issues
Source: Standard & Poor's (New York) and Author's Compilation
73
Methods 2 & 3:
Market-Based Measures
74
Updated Market-Based Annual Default Rate Forecast
Annual Default Rate (t+1) versus High-Yield Spreads (t)
Annual Default Rates (t+1) vs. Yield-Spreads (t) (1978-2012)
The regression equation is
Default Rate = - 3.27 + 1.33 * Spread
Default Rate (t+1) %
14
12
10
8
Predictor Coef
SE Coef
T
P
Constant
-3.2748 0.9693 -3.3782 0.0019
Spread
1.3274 0.1853 7.1642 0.0000
6
4
2
y = 1.3274x - 3.2748 R2 = 0.6160
0
0
2
4
6
8
10
12
S = 2.0064 R-Sq = 61.6% R-Sq(adj) = 60.4%
Yield-Spread (t) %
Application
Yield spread (12/30/2011) of 654bp, forecast PD for 2012 = 4.80%
vs. actual of 1.62%
Yield spread (12/31/2012) of 506bp, forecast PD for 12/31/2013 = 3.32%
vs. actual of 1.04%
Yield spread (12/31/2013) of 345bp, forecast PD for 12/31/2014 = 1.30%
Yield spread (01/15/2014) of 346bp, forecast PD for 01/15/2015 = 1.32%
Sources: Slides 3 & 8 and authors’ compilations
75
Distress Ratio History
2000 – 2013 (Preliminary)
Date
Distress Ratio
Annual Default Rate
(t+1)
12/31/2000
37.33
9.80
26.25
12/31/2001
24.36
12.79
52.52
12/31/2002
31.21
4.66
14.93
12/31/2003
8.40
1.25
14.86
12/31/2004
4.96
3.37
68.05
12/31/2005
5.47
0.76
13.92
12/31/2006
1.62
0.51
31.44
12/31/2007
10.35
4.65
44.97
12/31/2008
81.29
10.74
13.22
12/31/2009
14.53
1.13
7.78
12/31/2010
7.19
1.33
18.43
12/31/2011
17.88
1.62
9.06
12/31/2012
9.88
1.04
10.57
12/31/2013
5.29
n/a
n/a
Average
19.58
4.13
21.09
Median
10.35
1.62
14.93
Sources: Bank of America Merrill Lynch & NYU Salomon Center
Default Rate(t+1)
/Distress Ratio(t) (%)
76
Source: Bank of America Merrill Lynch
Distress Ratio
12/01/2013
06/01/2013
12/01/2012
06/01/2012
12/01/2011
06/01/2011
12/01/2010
06/01/2010
12/01/2009
06/01/2009
12/01/2008
06/01/2008
12/01/2007
06/01/2007
12/01/2006
06/01/2006
12/01/2005
06/01/2005
12/01/2004
06/01/2004
12/01/2003
06/01/2003
12/01/2002
06/01/2002
12/01/2001
06/01/2001
12/01/2000
Distress Ratio History
2000 – 2013 (Preliminary)
90.00
80.00
70.00
60.00
50.00
40.00
30.00
20.00
10.00
0.00
Median Distress Ratio
77
Estimated Size of the Distressed Bond
Market Based on Distress Ratio
HY Bond Mkt
Distressed Bond Mkt
1,500
1,350
1,200
1,050
750
600
450
223
16
5
18 21
9
10
1994
1996
1997
55
1993
150
102
1992
300
242
236
158
64 73
69 46 59
168
111
120
88
16
74
Sources: Distress Ratio used in calculations from BofAML. HY Bond Market size from NYU Salomon Center estimates.
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1995
1991
1990
$ Billions
887
900
78
Updated Market-Based Annual Default Rate Forecast
Annual Default Rate (t+1) versus Distressed Ratio (t)
Annual Default Rates (t+1) vs. Distress Ratios (t) (1990-2012)
The regression equation is
Default Rate = 0.86 + 0.14 * Distress Ratio
14
Default Rate (t+1) %
12
10
8
Predictor Coef
SE Coef
Constant
0.8634 0.4504
Spread
0.1412 0.0175
6
4
T
P
1.9170 0.0696
8.0626 0.0000
2
y = 0.1412x + 0.8638 R2 = 0.7647
0
0
20
40
60
80
S = 1.5731 R-Sq = 76.5% R-Sq(adj) = 75.3%
Distress Ratio (t) %
Application
Distress ratio (12/30/2011) of 17.88%, forecast PD for 2012 = 3.93%
vs. actual of 1.62%
Distress ratio (12/31/2012) of 9.88%, forecast PD for 12/31/2013 = 2.65%
vs. actual of 1.04%
Distress ratio (12/31/2013) of 5.29%, forecast PD for 12/31/2014 = 1.61%
Sources: Slide 6, Bank of America Securities and authors’ compilations
79
Default and Recovery Forecasts: Summary of
Forecast Models
2013 (12/31)
Default Rate
Forecast as of
12/31/2012
2014 (12/31)
Default Rate
Forecast as
of 12/31/2013
2015 (01/15)
Default Rate
Forecast as
of 01/15/2014
Mortality Rate
3.73%
3.25%
3.25%
Yield-Spread
3.32%a
1.30%c
1.32%e
Distress Ratio
2.65%b
1.61%d
1.61%f
3.23%
39.7%
2.05%
44.5%
2.06%
44.5%
Model
Average of Models
Recovery Rates*
* Recovery rate based on the log Linear equation between default and recovery rates, see Altman, et al (2005) Journal of Business, November and
Slide 80. a Based on Dec. 31, 2012 yield-spread of 505.8bp. b Based on Dec. 31, 2011 Distress Ratio of 9.88%. e Based on Dec.31, 2013 yieldspread of 344.6bp. d Based on Dec. 31, 2013 Distress Ratio of 5.29%. e Based on Jan. 15, 2014 yield-spread of 346.0bp. f Based on Dec. 31, 2013
Distress Ratio of 5.29%.
Source: All Corporate Bond Issuance and Authors’ Estimates of Market Size in 2013 & 2014.
80
Recovery Rate
Analysis
81
Default Rates and Lossesa
1978 – 2013 (Preliminary)
Year
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
Par Value
Outstanding ($MM)
1,392,212
1,212,362
1,354,649
1,221,569
1,152,952
1,091,000
1,075,400
993,600
1,073,000
933,100
825,000
757,000
649,000
597,200
567,400
465,500
335,400
271,000
240,000,
235,000
206,907
163,000
183,600
181,000
189,258
148,187
129,557
90,243
58,088
40,939
27,492
18,109
17,115
14,935
10,356
8,946
Par Value
Defaults ($MM)
14,539
19,647
17,963
13,809
123,878
50,763
5,473
7,559
36,209
11,657
38,451
96,858
63,609
30,248
23,532
7,464
4,200
3,336
4,551
3,418
2,287
5,545
18,862
18,354
8,110
3,944
7,486
3,156
992
344
301
577
27
224
20
119
Arithmetic Average 1978 – 2013
Weighted Average 1978 - 2013
a
Excludes defaulted issues..
Source: Authors’ compilations and various dealer price quotes.
Default
Rate (%)
1.04
1.62
1.33
1.13
10.74
4.65
0.51
0.76
3.37
1.25
4.66
12.79
9.80
5.06
4.15
1.60
1.25
1.23
1.90
1.45
1.11
3.40
10.27
10.14
4.29
2.66
5.78
3.50
1.71
0.84
1.09
3.19
0.16
1.50
0.19
1.33
Weighted Price
After Default ($)
53.6
57.8
60.3
46.6
36.1
42.5
66.6
65.3
61.1
57.7
45.5
25.3
25.5
26.4
27.9
35.9
54.2
51.9
40.6
39.4
56.6
50.1
36.0
23.4
38.3
43.6
75.9
34.5
45.9
48.6
55.7
38.6
12.0
21.1
31.0
60.0
Weighted
Coupon (%)
10.04
8.97
9.10
10.59
8.16
8.23
9.64
9.33
8.61
10.30
9.55
9.37
9.18
8.54
10.55
9.46
11.87
8.92
11.83
10.25
12.98
12.32
11.59
12.94
13.40
11.91
12.07
10.61
13.69
12.23
10.11
9.61
15.75
8.43
10.63
8.38
Default
Loss (%)
0.54
0.76
0.59
0.66
7.30
2.83
0.19
0.30
1.46
0.61
2.76
10.15
7.76
3.94
3.21
1.10
0.65
0.65
1.24
0.96
0.56
1.91
7.16
8.42
2.93
1.66
1.74
2.48
1.04
0.48
0.54
2.11
0.15
1.25
0.14
0.59
3.37
3.53
45.87
10.53
2.24
2.34
82
Recovery Rate/Default Rate Association
Dollar Weighted Average Recovery Rates to Dollar Weighted Average Default Rates
(1982 - 2013 (Preliminary))
70%
2007
2006
1987
2011
60%
y = -0.1069Ln(x) + 0.0297
R2 = 0.6287
y = -2.3137x + 0.5029
R2 = 0.5361
y = 0.1457x -0.2801
R2 = 0.6531
y = 30.255x2 - 6.0594x + 0.5671
R2 = 0.6151
2005
2012
2004
1993
1983
1997
2013
1996
1992
50%
Recovery Rate
1984
2010
1985
2003
1988
1995
1994
40%
2008
1982
1989
1998
2009
1991
1986
30%
1999
2000
2001
2002
1990
20%
10%
0%
2%
4%
6%
8%
10%
12%
14%
Default Rate
Note: 2013 Default Rate is Annualized
Source: E. Altman, et. al., “The Link Between Default and Recovery Rates”, NYU Salomon Center, S-03-4.
83
Annual Returns
(1978 – 2014 (1/15))
Yields and Spreads on 10-Year Treasury (Treas) and High Yield (HY) Bonds
a
Return (%)
Year
HY
Treas
Spread
HY
2014 (1/15)
0.89
1.17
(0.28)
6.34
2013
7.22
(7.85)
15.06
6.45
2012
15.17
4.23
10.95
6.80
2011
5.52
16.99
(11.47)
8.41
2010
14.32
8.10
6.22
7.87
2009
55.19
(9.92)
65.11
8.97
2008
(25.91)
20.30
(46.21)
19.53
2007
1.83
9.77
(7.95)
9.69
2006
11.85
1.37
10.47
7.82
2005
2.08
2.04
0.04
8.44
2004
10.79
4.87
5.92
7.35
2003
30.62
1.25
29.37
8.00
2002
(1.53)
14.66
(16.19)
12.38
2001
5.44
4.01
1.43
12.31
2000
(5.68)
14.45
(20.13)
14.56
1999
1.73
(8.41)
10.14
11.41
1998
4.04
12.77
(8.73)
10.04
1997
14.27
11.16
3.11
9.20
1996
11.24
0.04
11.20
9.58
1995
22.40
23.58
(1.18)
9.76
1994
(2.55)
(8.29)
5.74
11.50
1993
18.33
12.08
6.25
9.08
1992
18.29
6.50
11.79
10.44
1991
43.23
17.18
26.05
12.56
1990
(8.46)
6.88
(15.34)
18.57
1989
1.98
16.72
(14.74)
15.17
1988
15.25
6.34
8.91
13.70
1987
4.57
(2.67)
7.24
13.89
1986
16.50
24.08
(7.58)
12.67
1985
26.08
31.54
(5.46)
13.50
1984
8.50
14.82
(6.32)
14.97
1983
21.80
2.23
19.57
15.74
1982
32.45
42.08
(9.63)
17.84
1981
7.56
0.48
7.08
15.97
1980
(1.00)
(2.96)
1.96
13.46
1979
3.69
(0.86)
4.55
12.07
1978
7.57
(1.11)
8.68
10.92
Arithmetic Annual Average
1978-2013
10.95
8.01
2.94
11.68
Compound Annual Average
1978-2013
10.03
7.44
2.58
End-of-year yields. b Lowest yield in time series. Source: Citigroup’s High Yield Composite Index
Promised Yield (%)
Treas
2.88
3.01
1.74
1.88
3.29
3.84
2.22
4.03
4.70
4.39
4.21
4.26
3.82
5.04
5.12
6.44
4.65
5.75
6.42
5.58
7.83
5.80
6.69
6.70
8.07
7.93
9.15
8.83
7.21
8.99
11.87
10.70
13.86
12.08
10.23
9.13
8.11
6.49
Spread
3.46
3.45
5.06
6.54
4.58
5.14
17.31
5.66
3.11
4.05
3.14
3.74
8.56
7.27
9.44
4.97
5.39
3.45
3.16
4.18
3.67
3.28
3.75
5.86
10.50
7.24
4.55
5.06
5.46
4.51
3.10
5.04
3.98
3.89
3.23
2.94
2.81
5.20
84
Historic H.Y. Bond Return Estimation
Historic Yield-Spread
5.20%
Less: Historic Annual Loss from Defaults
(2.24)
Historic Expected Return Spread
2.96%
Historic Actual Return Spread
2.94%
Source: Ed Altman Calculations
85
Expected H.Y. Bond Return in 2014
Current Yield-Spread
3.46
Less: Expected Loss from Defaults
(1.15)
Expected Return Spread
2.31%
Plus: Current Yield 10 Yr T-Bonds
Estimated Return in 2014 on H.Y. Bonds
Source: Ed Altman Calculations
2.88
5.19%
86
Size of Distressed Debt
Market
87
Estimated Face And Market Values Of
Defaulted And Distressed Debt ($ Billions)
2011 – 2013 (Preliminary)
Face Value
Market Value
Market/Face
12/31/2011 12/31/2012 12/31/2013
Ratio
12/31/2011 12/31/2012 12/31/2013
Public Debt
Defaulted
251.63
252.39
247.90
(1)
88.07
100.96
111.55
0.45
Distressed
Total Public
Private Debt
209.79
461.43
130.06
382.45
76.06
323.96
(2)
146.86
234.93
91.04
191.99
53.24
164.79
0.70
Defaulted
503.27
504.78
495.79
(3)
251.63
277.63
347.06
0.70
419.59
922.85
1,384.28
260.11
764.89
1,147.34
152.12
647.91
971.87
(3)
293.71
545.34
780.27
208.09
485.72
677.71
121.69
468.75
633.54
0.80
Distressed
Total Private
Total Public and Private
1
Calculated using: (2012 defaulted population) + (2013 Defaults) - (2013 Emergences) - (2013 Distressed Exchanges).
Based on 5.29% of the high-yield bond market ($1.437 trillion) as of 31 Dec. 13.
3 Based on a private/public ratio of 2.0.
2
Source: NYU Salomon Center and estimates by Professor Edward I. Altman.
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Size Of The US Defaulted And Distressed Debt
Market ($ Billions)
1990 – 2013 (Preliminary)
$4,000
Face Value
Market Value
$3,500
$3,000
$2,500
$2,000
$1,500
$1,000
$500
$-
Source: Author’s Compilations
89