On November 13th S&P Capital hosted a webinar looking at trends and outlooks in the high yield markets. We had industry experts from S&P Capital IQ, Standard & Poor’s Ratings Service, and investment management firm Lehmann, Livian, Fridson Advisors LLC present. All brought an interesting perspective to the table and here are some of my key takeaways.
Probability of Default Trends
In Jim Elder’s S&P Capital IQ portion, the probability of default (PD) sector trends stood out the most. In particular, the energy sector’s (green line) median equity-based probability of default peaked at 5.5% in mid-October and ended around 3% by month end. To put this in perspective, over the last 33 years entities with a B+ S&P Credit Rating have experienced historical default rates of about 2.4% over a one-year time horizon. The median level of risk in this sector is rising as the shale boom drove more junk energy issuance this year. These companies are highly levered and as oil prices drop and break-even thresholds get closer, these default levels are something to watch for.
Data as of October 31, 2014
Michael Silverberg from S&P Ratings Services showed us the stark contrast in the fixed income markets from the end of 2009 to this year. In this chart below you can see the count of rated entities and distribution across the ratings spectrum in 2009 (blue) and 2014 (red). The portion of companies with a speculative grade issuer credit rating has increased from 40% in 2009 to 70% of the total universe as of August 31, 2014. The contrast in B rated entities provides a great visual. To me this showed the pronounced change in risk appetite and the ability for companies to enter the debt markets. As interest rates dropped to record low levels, speculative grade companies issued debt to take advantage of this and investors were willing buy this riskier paper in search of yield.
Lastly, Martin Fridson of Lehmann, Livian, Fridson Advisors LLC discussed his outlook on the market and industries that offer some good relative value. In the chart below, the vertical axis shows how an industry is trading relative to its ratings mix. So if every bond within the same industry and rating classification traded at the median bond level of its cohort then that industry would plot at 0 on the vertical scale. The horizontal axis shows the net ratings prospects for that industry, in other words it is companies on positive CreditWatch or Outlook minus those on negative CreditWatch or Outlook as a percentage of the number of rated companies in the industry. The best area is the north east quadrant which would be cheap relative to its rating and have an improving Ratings outlook. A few sectors that are in this section include Energy (EN), Gaming (AG), and Diversified Financials (FI). On a relative basis, energy appears cheap, but Marty does point out that this is the case if you believe that the decline in energy prices is short-term which is still left to be seen. On the other side investors are paying a premium for defensive industries such as Cable & Satellite TV (CV), Containers (CT) and Healthcare (HL) for what is presumed to be a safe haven. In addition Marty does point out this analysis is best suited to value investors. Over the short run, comparative industry returns tend to be determined by riskiness rather than valuation.
Data as of October 31, 2014
For more insights on High Yield market, click here to listen to our webinar replay.
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