Market Size, Investment Performance, and Expected New Supply of Defaulted Bonds & Bank Loans: 1987-1999

Abstract

This report presents results and discussion of the investment performance of those bonds and bank loans that have defaulted on their scheduled payments to creditors and continue trading while the issuing firm attempts a financial reorganization. Monthly total return measures are compiled based on the Altman-NYU Salomon Center Indexes of Defaulted Bonds and Defaulted Banks Loans, as well as an index that combines bonds and loans. These returns are compared to the total returns of common stocks and high yield corporate bonds. Returns are based on our market-weighted indexes and presented for the past year (1999), as well as for the last 13 years (for bonds) and four years for bank loans. We also estimate the expected supply of new defaulted debt in the United States for the coming three years. Nineteen ninety-nine was a mixed year for investors in distressed debt securities. Although the Defaulted Public Bond Index increased by a respectable 11.34% in 1999, the positive rate of increase was mainly a function of the excellent performance over a threemonth period in the earlier part of the year (February, March and April) when the size of the index was comprised of a relatively small number of securities and when the movement of a few issues had a significant influence on the Index. Still, the positive annual performance reversed the negative annual returns that we had observed in the prior two years. On a comparative note, our Defaulted Public Bond Index’s return of 11.34% was slightly higher than Salomon Smith Barney’s Bankrupt Bond Index return of 8.42%. Defaulted bank loans did not fare as well, recording a slight increase for the year of 0.65%. Except for the initial year (1996) of our Bank Loan Index, performance has been lackluster in the past three years. Finally, the Combined Public Bond and Private Bank Loan Index recorded a positive annual return in 1999 of 4.45%, resulting in a basically flat performance over the four years of the combined index calculation period. Comparative returns for the thirteen-year period (1987-1999), show that common stocks strengthened its number one asset class return/risk position. High yield bonds, while performing relatively poorly in 1999 (+1.7%), maintained a slight average annual return advantage over defaulted bonds. The two “bright” or positive factors related to the defaulted bond and bank loan markets in 1999 were the enormous increase in the supply of new defaulted issues and the record low average market value to face value ratio of the Index at the end of the year. The size of the Index more than doubled in number of issues and tripled in face and market values over the past twelve months as the default amount of high yield bonds reached a record high level in 1999 and the default rate went from 1.6% to over 4.0% (see our companion report on Defaults and Returns in the High Yield Bond Market). Based on our forecast of future defaults, we expect the number and amounts of the issues in both the Bond and Bank Loan indexes to continue to grow, albeit at a lower rate, in the next three years. Going forward, we suggest that this increased supply, and the relatively low marketto-face value ratio of defaulted bonds at the end of 1999, may present significant investment opportunities.