Monday, April 6, 2009

53% Of High Yield Companies To Default Over Next 5 Years

According to a research report by Jim Reid of Deutsche Bank, the 5 year cumulative default rate for US High Yield names will hit 53% assuming 0 recovery rates, and 69% assuming average recoveries. In Europe things are even worse: 65% and 81% respectively.

The 53% compares to a 45% default rate during the Great Depression, implying the credit market is anticipating a period of economic hardship over the next 5 years even worse than the "roaring" (for bankruptcy lawyers) 30's. Not surprisingly, default probabilities are again tied in to real estate valuations:

“We expect a continued fall in prices for one to two years in the U.S. and
longer in the U.K. and Europe." Reid wrote. The property market is "crucial to
consumer spending, the health of banks and the overall economy. The story is
certainly not over."
This may add more fire to the ongoing debate about the bifurcation between equities and credit, especially lower rated credit. As noted earlier, equities, unlike credit spreads, are trading at record trailing P&E's. Could this simply mean that hope, naivete and wide-eyed wonder are the key qualities of equity market participants, while anger, fear, aggression are traits of credit traders? Probably yes. Who is correct - again, one that likely will be answered relatively promptly.

hat tip hornai trader Sphere: Related Content
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Dippetydog said...

This report was from March 17th, gotta keep current! You've a nice ability to get ahold of a wide variety of reports though. I like.

Anonymous said...

Thank "Hornai trader"

Anonymous said...

As laid off equities person, can someone help with intuition vis-a-vis implied recoveries assuming historical and zero recovery?

Anonymous said...

anybody who claims that this is "research" is a moron. Yes Probabilty of default is proportional to the current Spread and Recovery. Anyone who knows anything about the market shoudl know what this P is under risk neutrality measure. For the lame of you , it means that most models assumes (incorrectly) that you are indifferent between holding a treasury with a known return and a risky (volatile) asset with the same expected return. So Saying that Spread S implies probability expectation P is simply wrong; the spread implies a significantly LOWER probability of default. This assumes zero volatilty of returns.