The speculative-grade global default rate is forecast to reach 2.1 percent in December, down from 2.9 percent at the end of 2013, according to a Moody’s note March 7. Default rates in Europe will fall to 5.2 percent next year, from 5.9 percent at the end of 2013, according to S&P.
At the same time, investors are demanding fewer protections. A measure of covenants on speculative-grade debt in North America were at weakest level in at least three years last month, Moody’s said in a March 11 report. A gauge of covenant quality that increases as investor protections deteriorate climbed to 4.36 last month from 3.84 in January, reversing three months of improvement. The ratings firm measures covenants on a scale of 1 to 5.
‘Lax Underwriting’
“The seeds of the high-yield demise are being sown with some lax underwriting,” said Anthony Valeri, a market strategist in San Diego with LPL Financial Corp. “But that probably won’t be a problem in the form of higher defaults until late this year.”
Yields on the riskiest dollar-denominated junk bonds have fallen to 9.7 percent through yesterday, Bank of America Merrill Lynch index data show. That’s 3.7 percentage points below than the average of the past decade, the data show.
Buyers demanded 3.78 percentage points more than similar- maturity Treasuries to own the debt rated CCC or below on March 5, the least since 2007, the data show. That’s not enough, according to Martin Fridson, chief executive officer of FridsonVision LLC, a New York research firm specializing in high-yield debt.
“We’re at an extreme over-valuation,” he said in a telephone interview. “When you’re not compensated adequately for the risk, you do tend to get punished for it. If the Fed is still sufficiently energetic about it, they could keep it at an over-valuation through all of 2014.”