Corporate Debt’s Dangling Default Dominoes

Last year’s corporate bond high-yield 5 percent default rate was the highest in the post-crisis period, with Latin America’s at double that damage, while the average 27 percent recovery was the lowest in five years, according to JP Morgan’s annual asset class roundup. It came despite moderation in overall distressed credit below under 70 cents/dollar, where the portion improved to 6.5 percent from 9.5 percent at mid-year, as the EMBI spread stands at 450 basis points over US Treasuries. Near $30 billion was unpaid, with Brazil’s Oi accounting for one-third and three Latin American names together 60 percent of the total. Missed interest owed and restructuring-bankruptcy was the main cause, along with discount and forced exchanges. China’s onshore market experienced dozens of cases but offshore was spared despite “close calls” like Glorious Properties, which needed a grace period. Europe’s 3.5 percent level came mostly from Ukraine, followed by Russia and Turkey. Africa had a big Nigerian oil firm default, but the headline bare miss was Venezuela’s $7 billion PDVSA quasi-sovereign swap with participation short of the 50 percent threshold. Coupon and amortization obligations are $8.5 billion over 2017 with residual credit event risk, the analysis cautions. In the last quarter commodity price recovery, capital spending retrenchment and liability management offered a rating downgrade respite, but demotions at almost 350 were triple upgrades for a 2016 “negative bias.” Value recovery approached half 2015’s 49% norm, with Latin America and Europe lagging and Asia largely in line with the above 50 percent historical trend. One of the top results was Ukraine Railway over 80 percent while Colombia’s Pacific Rubiales and Brazilian corporates were at bottom. China property firm Kaisa was an initial casualty but the outcome a “pleasant surprise,” while Mongolian Mining prices jumped from the teens to the 50s after negotiations. From this year 100 percent-owned quasi-sovereigns will be excluded from the company default tally, with PDVSA still on the watch list after the recent distressed transaction. Issuer removal after non-payment enabled 25 basis point shrinkage on the CEMBI benchmark, and the under 50 cents/dollar most impaired category remains dominated by Brazilian and neighboring and energy industry bonds.

The 2017 forecast is for a drop to 2 percent after the peak default cycle, with maturity pickup “benign” and economic fundamentals “stabilizing,” according to JP Morgan. However in specific countries, including Brazil where a corruption saga lingers, it warns of continuing risk aversion. Repayments from speculative and unrated issuers will be $60 billion, up from $35 billion last year but should be manageable, aided by ongoing buyback operations and insolvency code overhauls. On the latter, the IMF released an update on sovereign bond collective action clause incorporation to facilitate the workout process, with 75 percent of the $260 billion nominal amount containing them the past two years. New York law has a 90 percent incorporation rate, 10 percent above English jurisdiction. Modified pari passu provisions are routinely added, and the undertakings have “no observable” pricing effect, the Fund believes. The outstanding stock without these inserts is $850 billion, and trusts are increasingly replacing fiscal agent structures for contractual implementation responsibility. Future outreach will target Africa, Asia and non-euro Europe with less participation as sponsors try to assert their collective will, the document adds.