Daniel Arbess, head of special situations investing at Triton Partners, says the worst may not yet be over in terms of corporate defaults. He argues that more companies may face a refinancing crunch when senior secured bank debt negotiated in the late 1990s comes up for renewal in the next few years. Martin Fridson, high-yield strategist at Merrill Lynch, disagrees. He says that while leading indicators show that there may be a slight uptick in the default rate for the next few months, he expects a sharp drop in the default rate in 2004 and 2005.
While the multiple of senior secured bank debt to EBITDA was 4.8 in 1996, it has since fallen to 2.5, Arbess notes, citing data from Credit Suisse First Boston on issues above $300 million. "The implication is that what is believed to be the present peak in default rates may actually be anticipated to be a more prolonged wave of restructuring." Arbess argues that the best investment under such a scenario is in distressed debt. "There are profitable businesses with over-leveraged balance sheets where distressed debt securities are next generation equity securities in waiting," he says.
Merrill's Fridson says most defaults occur within three years after issuance, and issuance by companies rated B- or lower has dropped sharply of late. While issuance by such companies comprised 21% of the market in 1999, it was only 8% in 2001 and is just 8% again this year. "The bond-related data seems to suggest the big wave of defaults has already occurred," he says. Arbess observes that a number of defaults by higher quality issuers are still to be felt, however. "The defaults we've seen so far are the more low-hanging fruit. The next wave will come from the late 90s crop of better leveraged issuers that managed to squeeze through until refinancing, but may find themselves over-leveraged when they come to term," he says.