The gap between spreads on some of the lowest-rated high-yield credits is indicating a milder default climate ahead, according to Christopher Garman, head of high-yield strategy at Merrill Lynch in New York. He said the gap between triple-C and single-B is currently at around 425 basis points, well below the historical average of 660bps. Between 1992 and 1997, the spread differential between the two sectors was around 440bps and default risk decelerated during that span. "We're looking at a market in which stable spreads and decelerating default rates are occurring. The spreads capture the default risk fairly accurately and the high-yield bond market points to a 3% default rate going forward," added Garman. The current default rate is 3.4%, down from 5.2% in December and 6.1% in last June.
Hunkar Ozyasar, high-yield strategist at Deutsche Bank in New York, attributed the narrower gap between triple-Cs and single-Bs to the appreciation of triple-Cs and the recent high default rate, which forced defaulted companies to exit the sample. He added that securities from fixed-line telecom and utility issuers are sectors in which prices had notably appreciated. In mid-2002, fixed-line telecom, a sector comprised largely of single-B and triple-C credits, yielded 20% and it currently yields around 9%, he noted. The utility sector, which has more triple-C bonds, yielded 15-16% last year and currently yields 9.4%, Ozyasar stated.