Edward Altman: Risk in High Yield Market at 2007 Levels; Not Isolated to Energy
Edward Altman, Professor of Finance at New York University's Stern School of Business and a leading authority on the high yield and distressed debt market, says to expect more defaults this year and next with the average health of companies issuing high yield and investment grade bonds as risky today as they were in 2007, right before the last crisis. He also told Financial Sense that problems in the high yield space are no longer isolated to energy and mining and have undoubtedly spread to other parts of the economy.
Here's some of what he had to say on Friday’s podcast:
“Default rates among high yield bond companies…[are] definitely scaling up and the forecast for 2016 is to go above the historic average...
Yields have now increased dramatically and prices have fallen so the spread between high yield bonds and Treasuries now is around 800 basis points or 8%...so no longer is the cost of debt capital low for anybody raising it…
[O]ne could say that no longer are both investors and companies in this market in a low risk environment and that could escalate dramatically to the point where the bubble, which I also have been talking about, is building towards a potential bursting and that would be when default rates rise to 8-10% or higher, which is probably not going to happen this year but could happen soon thereafter…
One indication that it has spread to other companies [outside of energy and mining] is the proportion of high yield bonds that are selling at distressed levels and...a good percentage of the distressed companies now, which are the high potential candidates for default, are not energy and mining..."
Scroll down to read more of his comments, or click to hear a preview of his interview below.
"The Z-score is a measure that looks at the financial vulnerability or the financial health of companies and predicts whether or not they are likely to go bankrupt and it was a model I developed almost over 50 years ago…
Given that score we looked at the high yield bond issuers in 2007, which was right before the last crisis, and the end of 2014, which was the most recent annual data that we had and we looked at whether or not the average American company, particularly those issuing high yield bonds, actually got healthier or weaker in that seven year period.
What we found was quite surprising in that basically the average Z-score and the average health of companies issuing high yield and investment grade bonds did not change that much. In other words, it was just as risky in 2014 as in 2007 and, of course, '07 was right before the crisis when a large number failed in '08 and '09 when the default rate went above 10%...
So is that good news or bad news that it was no better or no worse than it was in '07? In fact, I think it's not very good news because I'm sure now that in 2015 [the average z-score] is actually lower [or worse]...because the amount of leverage that has been built up in the corporate area has been enormous…”
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