FIN-03-010 |
NYU Stern School of Business |
February 2003
Edward I. Altman and Guarav Bana
ABSTRACT
The year 2002 was remarkably difficult on many fronts for most financial
markets. For the high yield bond market, it was again a year of record amounts of
defaults which contributed to low recovery rates and slightly negative absolute
returns. The default rate registered a massive 12.8%, based on $757 billion
outstanding. Despite these record default totals and rates, the market’s decline was
orderly with little panic and actually ended the year with reduced defaults and
highly positive returns in the fourth quarter.
Default amounts registered its fourth consecutive record year and almost
topped $100 billion ($97.9 billion) for the first time. This total was more than 52%
higher than last year’s record. Combined with a near record low recovery rate of
25 cents on the dollar, weighed down by Telecom’s average recovery rate of 16%,
loss rates from defaults reached record levels of about 10% -- even adjusted for
fallen angel default recoveries. The pervasive influence of WorldCom’s massive
default had a profound effect on both the default and recovery rates. Without
WorldCom, the year’s default rate would have been 9.27% -- a differential of about
3.5%.
This report documents and comments upon the high yield bond market’s
risk and return performance over the period 1971-2002. We will present
traditional, dollar-denominated default rates as well as our own mortality rate
statistics. Default rate analysis will be complemented by discussion on corporate
bankruptcies and the immense impact of fallen angels on the high yield market. We
conclude with our annual estimate of the size of the distressed debt market and our
forecast for defaults in 2003. Our analysis will include an update on our default
recovery forecasting model which was extremely accurate in estimating 2002’s
recovery rate of about 25%.
Based on the fourth quarter’s reduction in default rate to 1.82% and our
aging-mortality conceptual framework, we are predicting a reduction in the dollar
denominated default rate to 7.5-8.0%, as much as 5% less than 2002 (but still far
above the average rate). This should help provide a more attractive environment for
high yield debt new issues and returns in 2003.
In 2002, there was $65.6 billion in new high yield bond issuance, down from
2001’s $88.2 billion. We expect new issuance in 2003 to escalate unless the
economic/political scene motivates another flight to quality in our financial markets.
Classification: G15, G21, G28
Edward I. Altman
Institution: Stern School of Business, New York University, 44 West 4th Street, New York, NY 10012
Telephone: (212) 998-0709
Email: ealtman@stern.nyu.edu
Homepage:http://www.stern.nyu.edu/~ealtman
Gaurav Bana
Institution: Research Associate at the NYU Salomon Center.
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