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Defaults & Returns on High Yield Bonds: Analysis through 1999 and Default Outlook for 2000-2002

Authors: Altman, Edward I.
Hukkawala, Naeem
Kishore, Vellore
Issue Date: Jan-2000
Series/Report no.: FIN-99-005
Abstract: Full year 1999 was again a mixed performance year for the high yield bond market in the United States but for different reasons than the mixed 1998 performance. Once again, total returns were lackluster, registering just +1.73%. But, unlike last year’s companion negative return spread vs. U.S. ten-year Treasuries, the return spread in 1999 was a positive 10.1%, as yield spreads increased significantly and Treasuries tumbled. And again, new issuance of high yield bonds was impressive, topping $100 billion for the third consecutive year, but aggregate defaults increased dramatically to an all-time record level of over $23 billion (face value). The default rate registered a sizeable increase, topping 4% (4.15%) for the first time since 1991 and significantly above the 1.6% level of one year earlier. Combined with a relatively low recovery rate of below 30 cents on the dollar, the default loss rate was 3.2% in 1999, compared to a historical arithmetic annual average of 1.9%. Despite 1999’s low absolute return, net returns (after deducting losses from defaults, rating migrations and interest rate changes) for the 1978-1999 period continued to show an attractive compounded return spread over U.S. Treasury bonds of close to 3.0% per year (2.96%). This report documents the high yield bond market’s risk and return performance by presenting traditional and mortality default rate statistics and providing a matrix of performance statistics over the relevant periods of the market’s evolution. Our analysis covers the 1971-1999 period for defaults and the 1978-1999 period for returns. In addition, we present our annual forecast of expected defaults for the next three years (2000-2002). Our 1999 forecast was for substantially higher defaults than 1998, but we underestimated the record default levels. Default levels and rates were swelled in 1999 due to a number of factors, including the huge new issuance in the 1997-1999 period, a trend toward earlier defaults, deteriorating credit quality of new issues, pockets of industry fragility, and the continued vestige of 1998’s flight to quality. For 2000, we expect default levels to decline to about $17.5 billion and the default rate to regress to around three percent of the amount outstanding.
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