is there more upside in high yield? dc finance institutional investor conference may 24, 2010
TRANSCRIPT
Is There More Upside in High Yield?
DC Finance Institutional Investor Conference
May 24, 2010
2
Global Credit Strategy
● Par is not a ceiling
● The key is what happens to the default rate
● Economic trend favors a lower default rate
● Diverse approaches point to a default rate decline
● “Wall of Maturities”: An overstated problem
3
Par Is Not a Ceiling
4
After This Big a Rally, Can We Expect Good Performance?
All-Time High (28 Feb 2005)
Average (1998 - 2009)
All-Time Low ( 12 December 2008)
PAR
50
60
70
80
90
100
110
D J F M A M J J A S O N D J F M
2009 2010
Pri
ce o
f G
lob
al H
igh
Yie
ld I
nd
ex
Source: BofA Merrill Lynch Global Research.
5
There Is Upside from 100
U.S. High Yield Year Index Beginning Price
1997 99.483
2004
Income
Price Gain
Total Return
Key:
Source: BofA Merrill Lynch Global Research.
Total Return for the Year
9.12%
4.15%
7.00%
2.60%
7.77%
2.62%
High Yield Government Investment GradeCorporates
13.27%
9.60%10.39%
8.46%
2.41%
4.36%
-0.94%
5.95%
-0.53%
High Yield Government Investment GradeCorporates
10.87%
3.42%
5.42%
102.621
6
The Key Is What Happens to the Default Rate
7
Change in Default Rate versus High Yield Price Return
-3.32
3.95
-5
-4
-3
-2
-1
0
1
2
3
4
5
Rising Default Rate Declining Default Rate
Mea
n P
rice
Ret
urn
(%
)
1987 – 2009, Annually
Sources; BofA Merrill Lynch Global Research, Moody’s Investors Service.
In 17 out of 23 years, the default rate and the high yield index price moved in opposite directions
8
Economic Trend Favors a Lower Default Rate
9
Real Growth in GDP – Germany
2008 – 2010, Quarterly
Sources; Bloomberg.
-8
-6
-4
-2
0
2
4
6
1 2 3 4 1 2 3 4 1 2 3 4
2008 2009 2010Ch
ang
e o
ver
Pre
ced
ing
Per
iod
- A
nn
ual
Rat
e (%
)
Historical Projected
10
Real Growth in GDP – U.S.
2008 – 2010, Quarterly
Sources; Bloomberg.
-8
-6
-4
-2
0
2
4
6
8
10
1 2 3 4 1 2 3 4 1 2 3 4
2008 2009 2010Ch
ang
e o
ver
Pre
ced
ing
Per
iod
- A
nn
ual
Rat
e (%
)
Historical Projected
11
Real Growth in GDP – U.K.
2008 – 2010, Quarterly
Sources; Bloomberg.
-8
-6
-4
-2
0
2
4
6
8
1 2 3 4 1 2 3 4 1 2 3 4
2008 2009 2010Ch
ang
e o
ver
Pre
ced
ing
Per
iod
- A
nn
ual
Rat
e (%
)
Historical Projected
12
Diverse Approaches Point to a Default Rate Decline
13
Global Default Rate
1985-2010, Quarterly
Sources: BNP Global Credit, Moody’s Investors Service. - - - Moody’s projection
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
1Q
85
1Q
86
1Q
87
1Q
88
1Q
89
1Q
90
1Q
91
1Q
92
1Q
93
1Q
94
1Q
95
1Q
96
1Q
97
1Q
98
1Q
99
1Q
00
1Q
01
1Q
02
1Q
03
1Q
04
1Q
05
1Q
06
1Q
07
1Q
08
1Q
09
1Q
10
Qu
arte
rly
Rat
e (%
)
3.78%
Projected April 2011: 0.50%
Mean = 1.24%
Moody;s employs atime-tested econo-metric model
14
Liquidity Correlates with Default Rate
0
10
20
30
40
50
60
1 2 3 4
Speculative - Grade Liquidity Rating
One
-Yea
r D
efau
lt R
ate
(%)
M
arch
200
9 to
Mar
ch 2
010
Source: Moody's Investors Service.
The least liquidcompanies defaultat a much higher ratethan the others
15
Liquidity Improvement Points to Default Rate Decline
0
5
10
15
20
25
J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M
2007 2008 2009 2010
SG
L-4
as P
erce
nt o
f All
SG
L R
atin
gs
Source: Moody's Investors Service.
The number of highlyilliquid companies hasfallen dramatically
16
Market-Based Default Rate Forecast
Source: BofA Merrill Lynch Global Research.
As of May 6, 2010
The proportion of companieswith spreads greater than +1,000basis points has declined from apeak of 84% in December 2008
Distribution Annualof High Yield Default WeightedUniverse (%) Rate (%) Average (%)
Distressed 9.87% x 23.53% = 2.32%Non-distressed + 90.13% x 1.23% = 1.11%Cyclical Adjustment Factor + -0.75% = -0.75%
Default Rate Forecast = 2.68%
17
“Wall of Maturities”: An Overstated Problem
18
Distribution of U.S. Debt Maturities
2010-2020, Annually
0
50
100
150
200
250
300
350
400
450
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
$ B
illio
n
High Yield Bonds Leveraged Loans
Source: BofA Merrill Lynch Global Securities.
Maturing debt is not a significant problem in 2010-2011
19
Projected Resolution of 2010-2014
$770 Billion Leveraged Loan Maturities
Source: Fitch Ratings.
$425 Billion Loan Refinancing
$75 Billion Other
$55 Billion Mandatory
Prepayments
$86 Billion Bond- for-Loan Takeouts
$135 Billion Amend + Extend
Agreements Fitch sees 90% of maturities being resolved before taking into account equity issuance oracquisitions
20
Fitch’s Key Assumptions
● Loan issuance at 1998-2003 level (before CLO boom)
● Only modest CLO new issuance
● 45% of loan issuance used to refinance loan maturities
● $125 billion annual high yield issuance – below peak levels, which are considered unsustainable
● Non-refinancing uses of high yield issuance at levels consistent with historical experience
21
Conclusion
We cannot travel backward in time to buy the high yield market at 54,
But among the opportunities available today, high yield remains attractive.
High Yield should outperform conventional fixed income over the next 12 months.