Fra Moodys


Corporate Credit Is in Late-Cycle Mode

The composite speculative grade bond yield refuses to sit still. After bottoming at the 6.01% of late April 2015, the speculative grade bond yield would eventually climb all the way up to the 10.17% of February 11, 2016. Thereafter, the yield quickly sank to 8.26% by the middle of March, only to jump up to 8.61% by the end of March. However, by April 13, the spec-grade yield had quickly descended to 8.04%.

Because a continuation of subpar revenue growth is likely, high yield’s latest rally is susceptible to yet another reversal. After reaching Q3-2014’s 5.3%, the yearly increase of core business revenues (which exclude sales of identifiable energy products) slowed in each of the five subsequent quarters to the 1.4% of 2015’s final quarter. Recent data suggest that this metric may have improved to a still mediocre 1.9% annual increase for 2016’s first quarter. Nevertheless, the projected yearly increase by Q1-2016’s core business revenues falls noticeably short of the expected 4.8% yearly increase by private-sector wage and salary income and thus warns of a further narrowing by profit margins.

Steepest upswing by downgrades to “Caa3 or lower” since winter of 2008-2009 warns of more defaults Narrower margins will probably reinforce the now rising trend of high yield defaults. The number of UScompany credit rating downgrades to the very low high yield rungs of Caa3 or lower jumped up from Q1- 2015’s 12 and Q4-2015’s 33 to 66 in Q1-2016, wherein 35 of Q1-2016’s 66 downgrades stemmed from oil & gas related difficulties.

First quarter 2016’s number of downgrades to Caa3 or lower was the most since the 87 of Q2-2009. The number of downgrades to Caa3 or lower previously jumped up to at least 66 in Q1-2009. The latest surge by downgrades to 66 strongly supports the realization of a roughly 6.0% high yield default rate six to 12 months hence. The correlation between the default rate and the yearlong number of downgrades to “Caa3-or-lower” lagged one quarter is a very strong 0.96. According to the latter relationship, the midpoint for Q3-2016’s expected default rate is now 6.5%. (Figure