Bonos ‘high yield’: buenos por defecto

Greg Venizelos, estratega del equipo de Research de AXA IM - Viernes, 09 de Diciembre

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High Yield Credit – good by default 

Improving default outlook for US HY, both outright and relative to EU HY

Presenting an update of our default valuation model for High Yield (HY) credit, Greg Venizelos highlights the improving default outlook for US HY, both outright and relative to European HY. The overvaluation of US HY credit has narrowed materially as a result, while European HY remains marginally cheap.

High yield credit – good by default

Improving default outlook for US HY, both outright and relative to EU HY

•   Our twelve month default rate forecast for US high yield (HY) now stands at 3.6% (peak forecast was 6%+) and 2.1% for European HY.

•   The twelve month default rate should peak at just under 6% in January-February 2017 as should the US-EU default rate differential at just over 4%.

•   European HY remains cheap from a default valuation perspective; US HY remains rich but has been improving. Our excess spread estimates now stand at 309bps for European HY (0.2 sigma) and 217bps for US HY (-0.9 sigma).

  The easing of lending standards in the US and the rally in spreads have softened both factors that feed as inputs to our default rate model. The Fed Loan Officer survey has dropped to near flat (1.5% net tightening), after reaching a post financial crisis peak in April (11.6%). At the same time, the remarkable rally in energy and recourse sectors’ spreads has returned the distress ratio (share of bonds trading wider than 1000bps) to late 2014 levels, after reaching a 30%+ peak in February. In Europe, the improvement in the distress ratio has been less dramatic (equally, its February peak was less dramatic) while the ECB lending survey has drifted into tightening territory again for the first time since late 2013.

  These changes in our model inputs give rise to a default rate forecast (see table) that is less hawkish for the US and less dovish for Europe than our previous expectations. We are now more bullish than Moody’s for US HY (AXA IM 3.6% vs Moody’s 4.1%) and comparable for European HY (AXA IM 2.1% vs Moody’s 2.2%). This is in contrast to a year ago when our model was more bearish for the US than Moody’s and materially more dovish for Europe, a difference which did indeed materialise.

  Moody’s default rate forecast is higher than ours for the US and comparable for the EU

  AXA IM R&IS 3.6% 2.1% 1.5% Moody’s 4.1% 2.2% 1.9%

  Source: Bloomberg, BAML, Moody’s and AXA IM Research – As of 1 December 2016

  One area where we agree with Moody’s is that January-February 2017 should see the US default rate peak at just under 6% and the US-EU default rate differential peak at just over 4% (Exhibits 1 and 2). We do, however, predict a more material narrowing in the US-EU default rate differential by this time next year, to 1.5% vs Moody’s ~2% (also shown in table above).

  In earlier work1 we showed that, historically, approximately one third of HY spreads is eaten up in default losses, so approximately two thirds of the spread remains as excess spread. In Exhibits 3 and 4, we calculate the excess spread after netting-out default losses from the spot spread, for a range of default rates (see along the top row) and recovery rates (see down the left column). The grey contour is mapping the fair value as approximately two thirds of the spot level (two thirds equals whole minus one third of default losses). Excess spreads that lie northwest of the contour are cheap and excess spreads that lie southeast of the contour are rich. The yellow cell shows the excess spread that corresponds to our default rate forecast and recovery rate expectation. The excess spread currently stands at 309bps for European HY (0.2 sigma cheap) and 217bps for US HY (0.9 sigma rich). European HY has been moderately cheap for some time now while US HY has improved materially from being much richer earlier in the year (was at -1.5 sigma).

12-month default rate forecast
	US	EU	US-EU

1 Venizelos, G., “1/3rd of credit spreads account for expected default losses”, AXA IM Research, 10 November 2015

Exhibit 1

US default rate to peak in early 2017

Exhibit 2

Moody’s default rate also set to peak in early 2017

AXA IM default rate model 16%

US
EU US-EU

2015 2017

12% 8% 4% 0% -4%

-8%
2005 2007

2009 2011 2013

Moody's default rate

fcast

US 16%

EU US-EU

2013 2015

12% 8% 4% 0% -4% -8%

2005 2007

2009 2011

2017

Source: Bloomberg, BAML and AXA IM Research

Exhibit 3

EU HY excess spread* remains marginally cheap

429 429 429 429 429 429 429 429 427 424 422 419 417 414 429 424 419 414 409 404 399 429 422 414 407 399 392 384 429 419 409 399 389 379 369 429 417 404 392 379 367 354 429 414 399 384 369 354 339 429 412 394 377 359 342 324 429 409 389 369 349 329 309 429 407 384 362 339 317

Source: Moody’s and AXA IM Research

EU

HY INDEX EXCESS SPREAD

(spot 429bps)

100 95 90 85 80 75 70 65 60 55 50 45 40 35

0

Annual default rate

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

5.5

6

6.5

7

7.5

299 289 279

304 292 279 267

294 279 264

289 272

289 269

304 279 292 264

294 272

309

279

299 267

30 25 20 15 10

5 0

302 294 287 279

289 279 269

Excess spread at fair value

Excess spread based on our default & recovery forcasts

429 429 429 429 429
412 409 407 404 402
394 389 384 379 374
377 369 362 354 347
359 349 339 329 319 309 342 329 317

429 429 394 392 359 354 324 317

254 242 219 204 184 167 149 129 114 92

79 54 44 17 9 -21 -26 -59 -61 -96 -96 -134 -131 -171 -166 -209 -201 -246 -236 -284 -271 -321

429 429 399 397 369 364 339 332

429 404 379 354 329 429 402 374 347 319 429 399 369 339
429 397 364 332

324 309
307 254 237

249 229 209 249 227 204 182 254 229 204 179 154 237 209 182 154 127

249 234 219 202 189 169 159 137 129 104

99 71 69 39 39 7

9 -26 -21 -59 -51 -91 -81 -124

249 219 189 159 234 202 169 137

129 99 104 71 79 44 54 17 29 -11 4 -39

429 394 359 324 429 392 354 317 429 389 349 309 429 387 344

429 384 339 429 382 334 429 379 329

254 219 242 204 229 189

259 217 174 249 204 159 239 192 144 229 179 129

184 149 114 167 129 92 149 109 69 132 89 47 114 69 24

97 49 2 79 29 -21

-21 -66 -111 -156 -46 -94 -141 -189 -71 -121 -171 -221

* Excess spread = spot spread - default rate * ( 1 - revovery rate )
Source: Bloomberg, BAML and AXA IM Research - As of 1 December 2016

2  AXA INVESTMENT MANAGERS - INVESTMENT RESEARCH - 07/12/2016

Recoverry rate

Exhibit 4

US HY excess spread* remains rich but much less so than one year ago

US

HY INDEX EXCESS SPREAD

(spot 462bps)

100 95 90 85 80 75 70 65 60

0

Annual default rate

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

5.5

6

6.5

7

7.5

322

312

312 300

287

322 302

282

312 297 282

322 305 287

55 50

305

282

45 40 35 30 25 20 15 10

5 0

312 287

297

312 282

300

320 312

322 287

312 302 292 282

Excess spread at fair value

Excess spread based on our default & recovery forcasts

462 462 462 462 462

462 460 457 455 452

462 457 452 447 442

462 455 447 440 432

462 452 442 432 422

462 450 437 425 412 462 447 432 417 402

462 445 427 410 392 462 442 422 402 382

462 440 417 395 372 462 437 412 387 362 462 435 407 380 352 462 432 402 372 342 462 430 397 365 332 462 427 392 357

462 425 387 350 462 422 382 342 462 420 377 335 462 417 372 327 462 415 367

462 412 362

462 462 462 462 450 447 445 442 437 432 427 422 425 417 410 402 412 402 392 382 400 387 375 362 387 372 357 342 375 357 340

362 342
350 327
337 262 325 270 242

252 222 267 235 202

462 462 462 462 462 462 462 440 437 435 432 430 427 425 417 412 407 402 397 392 387 395 387 380 372 365 357 350 372 362 352 342 332

350 337 325 275 327 267 252 237 270 252 235 217 200 262 242 222 202 182 162 260 237 215 192 170 147 125 237 212 187 162 137 112 87 215 187 160 132 105 77 50 192 162 132 102 72 42 12 170 137 105 72 40 7 -26 147 112 77 42 7 -28 -63 125 87 50 12 -26 -63 -101 102 62 22 -18 -58 -98 -138 80 37 -6 -48 -91 -133 -176 57 12 -33 -78 -123 -168 -213 35 -13 -61 -108 -156 -203 -251 12 -38 -88 -138 -188 -238 -288

* Excess spread = spot spread - default rate * ( 1 - revovery rate ) Source: Bloomberg, BAML and AXA IM Research - As of 1 December 2016

252 217 182 275 237 200 162 262 222 182 142 250 207 165 122 237 192 147 102 272 225 177 130 82 262 212 162 112 62

AXA INVESTMENT MANAGERS - INVESTMENT RESEARCH - 07/12/2016  3

Recoverry rate 

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