Corporate Defaults’ Devilish Plot
The mid-year high-yield CEMBI corporate default rate at 2.5 percent was on track for 2015’s 5 percent projection, with 20 “fallen angels” already with the rating upgrade/downgrade ratio at 0.3 according to index sponsor JP Morgan. All regions were hit with Brazil’s half dozen the most names while Ukraine’s issuers have not yet felt the brunt of the pending sovereign restructuring. Distressed exchanges have so far outnumbered bankruptcies for higher recovery rates at almost 50 versus the historical 35 percent. Almost 15 percent of the universe currently trades at the problem 70 cents/dollar handle with Venezuela’s $35 billion in PDVSA bonds 95 percent of the total. Outside energy, metals and mining is the riskiest sector and through July rating downgrades at over 250 were almost triple upgrades. Most of the falls from investment-grade to junk were in Latin America but China and Russia were also caught in the trend, while Mexico and Korea had net improvement. By volume real estate has been most default-prone led by Kaisa’s collapse and failed merger attempt, while financials have traditionally dominated since 2010. Just prior to the episode the rating has been in the lowest “B” category, and since the 2008 crisis 20 countries have experienced non-payment.
The greatest corporate pressure may now be on Brazil with likely sovereign demotion to speculative grade in 2016 on worsening recession and public debt and the effects of the Petrobras and related state corruption scandals. An estimated $15 billion in forced selling from active and passive investors could result, about 10 percent of prime-quality bonds. All three major raters have assigned negative outlooks and banks and companies would be expected to follow Petrobras into the high-yield space where only a few feature in US “crossover” indices. Bank of America/Merrill Lynch in anticipation will recast its benchmark with a no-emerging market issuer option, which would leave the field to dedicated investors now underweight with the cascade of leverage and investigation woes. Removal from the CEMBI investment-grade would benefit other countries with Korea and the UAE increasing their top portions to a combined 15 percent.
China’s equity wipeout and intervention has transferred the local funding burden back to debt, with shadow banking as a main bond route down to one-third of intermediary activity. The PMI has reverted to 50 and foreign investors are now the target of high-frequency and short-selling probes to quash broad allocation appetite. Real estate monthly sales are still slack in second-tier cities and capital outflows persist with -50 billion international bank lending in Q1 according to BIS figures. Hong Kong is going ahead with long planned Chinese railway and asset management company IPOs due for lackluster reception as Russian banks and companies also looking there to escape Western sanctions may find the channel blocked. At home the central bank dropped interest rates another 50 basis points but indicated future moves would be minimal with the stronger ruble and double-digit inflation. The US Treasury stiffened boycotts and freezes on Ukrainian firms and individuals tied to the former regime as the next IMF $1.7 billion chunk was received and bondholders conceded the prospect of a small haircut for the first time in talks. However public confidence in the government has also been scalped, with Prime Minister Yatseniuk’s approval in single digits.
