We see default risk as the most prominent risk for credit investors. As we look forward, a benign default environment is projected over the next few years.1
Broadly speaking, this projection does make sense to us. Some of the triggers for default include an inability to continue servicing debt by paying the semi-annual interest on the bonds, as well as an inability to repay or refinance the bonds upon maturity. As J.P. Morgan recently noted2:
Combined, high-yield bond and loan issuance totaled $1.9trn over the last two years, with the emphasis of this on refinancing. As a result, maturities between now and 2017 remain low and are lower than where they stood several years ago. As it stands, only $31bn of high-yield bonds and loans come due between now and yearend, while only $85bn in debt comes due in 2016, making the total amount of debt set to mature in the next two years a mere $116bn, an amount equal to roughly four-and-a-half months refinancing volume based on last year’s run rate. Further, over the next two and three years a mere 4.5% and 10.9% of the $2.6trn leveraged credit market will mature. By comparison, at year end 2010, 10.1% and 21.2% of the market was coming due in two and three years, double today’s levels.
The low interest rate environment and wide open refinancing market have allowed companies to push out their maturities and add liquidity to their balance sheets, positioning them well for the years ahead. And as noted, this new issuance activity has largely been for refinancings, not massive acquisitions or LBOs, indicating that companies are not levering up their balance sheets as we have seen in past cycles.3
Looking at the default outlook another way, as we begin 2015, the projected default rates are well below what the spread level would imply as the future default rate:4