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Edward Altman |
Are historically based default and recovery models in the high yield and distressed debt markets still relevant in today’s distressed debt markets? New York Professor, Ed Altman issues a caution on future default rate forecasts.
On Friday, at PRMIA’s Frontiers in Credit Forum in New York, Edward Altman, Max L. Heine Professor of Finance at New York University’s Stern School of Business, presented his latest forecasts on default rates for corporate high-yield, non-investment grade bonds.
Using his model based on mortality rates, Professor Altman forecasts a default rate of 2.5% in 2007 and 3.7% in 2008. While higher than the current rate of 0.76%, these default forecasts are well below the historical average of 4.2%. Leveraged loans are also currently exhibiting similarly low historic rates of default.
Professor Altman points out that this is the lowest default rate in 25 years on corporate high-yield non-investment grade bonds, and the highest recovery rate ever. He attributes this to the unusually high volume of liquidity, accelerated by the hedge and private equity funds, chasing too few defaults. Other influences were rescue financing restructurings, pre-petition credit facilities, distressed debt control investing and exit financing.
Today’s average loan in default sells at $0.93 on the dollar, an amount very close to that of the average on new defaults. Driving these trends are an estimated 170 managers of distressed debt in the US alone.
While Professor Altman is not necessarily forecasting a drying up of liquidity, he does caution that corporate fundamentals and poor new bond and loan quality point toward significantly higher default rates in the future.
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