After five issuer defaults already this month accounting for nearly $2 billion in new volume, Fitch Ratings now expects the US high-yield default rate to end 2015 at around 3.5% -- above the 2.9% trailing 12- month (TTM) rate through September. This higher expectation -- from the previous range of 2.5% to 3% -- reflects ongoing strife in the energy and metals/mining sectors.
Fitch notes its expectation of a mid-three percent default rate is materially above the average during non-recessionary periods of 2%. (The average rate during recessionary periods is 11%.)
Risks to our default rate expectation are to the downside, with a 4% rate more likely than a 3% rate for year-end 2015. The overall default rate is set to rise further in 2016.
The market is clearly bifurcated -- the commodity complex is in a down cycle while the rest of the market is exhibiting relative benign default trends.
For example, September energy and metals/mining trailing TTM default rates stood at 5% and 10%, respectively. The energy default rate is at its highest level since 1999, when it registered 10%. Energy and metals/mining entities accounted for 90% of third quarter defaults. These sectors experienced three consecutive months with over $4 billion in defaults, a level not seen since 2009 when monthly volume in the entire market exceeded $4 billion for seven straight months.
By contrast, the default rate is below 1% after removing energy and metals/mining defaults as well as Caesars Entertainment Operating Co. (which defaulted in January) from the September TTM figure.
It would take approximately $19 billion of additional default volume in the final three months to reach a 4% default rate for 2015. This value of defaults would be more than the average fourth quarter defaults of $6 billion during the non-recession years since 2010 but well below the recessionary peak of $33 billion experienced in the final quarter of 2008.
Price collapses and oversupply continue to afflict the energy and metals/mining sectors and are reflected in their bond prices. Roughly $82 billion of outstanding energy and metals/mining bonds are rated 'CCC' or lower. About half of energy and metals/mining bond issues (which comprise 22% of the overall high yield market) are bid below 80 cents, compared to 10% for the rest of the universe. Just 7% of energy and metals/mining was bid below 80 one year ago.
Further, a material number of bonds in the space are bid below 40 cents, including Arch Coal Inc. and Peabody Energy Inc., with a combined $8 billion of bond debt. Chapter 11 filings by both companies would add 0.5% to the default rate.
Asset-based revolver borrowing base resets for several troubled energy companies are slated for later this month, placing further pressure on liquidity as oil prices as of yesterday are near $50 a barrel.