Defaults & Returns on High Yield Bonds: Analysis Through 1999 and Default Outlook for 2000-2002
39 Pages Posted: 7 Nov 2008
Date Written: January 2000
Full year 1999 was again a mixed performance year for the high yield bondmarket in the United States but for different reasons than the mixed 1998performance. Once again, total returns were lackluster, registering just +1.73%. But, unlike last year s companion negative return spread vs. U.S. ten-year Treasuries, the return spread in 1999 was a positive 10.1%, as yield spreads increased significantly and Treasuries tumbled. And again, new issuance of high yield bonds was impressive, topping $100 billion for the third consecutive year, but aggregate defaults increased dramatically to an all-time record level of over $23 billion (face value). The default rate registered a sizeable increase, topping 4% (4.15%) for the first time since 1991 and significantly above the 1.6% level of one year earlier.Combined with a relatively low recovery rate of below 30 cents on the dollar, thedefault loss rate was 3.2% in 1999, compared to a historical arithmetic annualaverage of 1.9%. Despite 1999 s low absolute return, net returns (after deducting losses from defaults, rating migrations and interest rate changes) for the 1978-1999 period continued to show an attractive compounded return spread over U.S. Treasury bonds of close to 3.0% per year (2.96%). This report documents the high yield bond market s risk and returnperformance by presenting traditional and mortality default rate statistics andproviding a matrix of performance statistics over the relevant periods of themarket s evolution. Our analysis covers the 1971-1999 period for defaults and the 1978-1999 period for returns. In addition, we present our annual forecast of expected defaults for the next three years (2000-2002). Our 1999 forecast was for substantially higher defaults than 1998, but we underestimated the record defaultlevels. Default levels and rates were swelled in 1999 due to a number of factors,including the huge new issuance in the 1997-1999 period, a trend toward earlier defaults, deteriorating credit quality of new issues, pockets of industry fragility, and the continued vestige of 1998 s flight to quality. For 2000, we expect default levels to decline to about $17.5 billion and the default rate to regress to around three percent of the amount outstanding.
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