By: Russ Kamp, Managing Director, Ryan ALM, Inc.
S&P is out once again with its outstanding research on corporate defaults with the publication of the “2021 Annual Global Corporate Default And Rating Transition Study”. Despite significant issues related to business continuity from Covid-19, supply chain disruptions, inflation, etc. global corporation defaults remained incredibly low. As the chart below reflects, the last 40-years for investment-grade bonds reveal almost no defaults. Is the party about to end?
The US bond market has enjoyed an unparalleled 39-year bull market that has seen interest rates fall from the mid-teens in 1981 to historically low levels until recently. The US Federal Reserve has embarked on a potentially aggressive tightening path that may lead to significantly higher US interest rates. How will this trend impact those companies that have maintained their IG rating despite having modest interest coverage ratios that may become quite challenged in the near future? As a reminder, a significant majority of corporate debt issuance has been rated BBB, and that category now makes up >50% of all IG debt outstanding. Another interesting fact, despite the relative calm, overall credit quality has deteriorated. According to the S&P report, the “ratings distribution among companies we rate remained weak, with 14.5% of ratings at ‘B-‘ or lower as of year-end, up from 7.4% 10 years earlier.” Could this be the canary in the coal mine?
Total return bond products have had a very difficult start to 2022, with the Bloomberg Barclays Index (still the dominant index for Pension America) down 6% in the first quarter. To date, these bond funds have only had to deal with interest rate risk. Let’s see what happens when defaults escalate.