Credit Suisse First Boston is once again the far and away leader in terms of volume of high-yield issues managed since 1998 that subsequently defaulted, according to BondWeek's third annual Turkey Tables. Morgan Stanley and Goldman Sachs moved up considerably, due mostly to the tremendous number of defaults this year.
CSFB's ranking was influenced largely by its acquisition of high-yield juggernaut Donaldson, Lufkin & Jenrette, which brought $7.2 billion in deals to market that subsequently defaulted, according to default data supplied by Moody's Investors Service (see list of all defaulted deals on www.bondweek.com). The combined entity saw $9.4 billion default.
When the defaults are viewed as a percentage of total principal and as a percentage of total issues, Jefferies & Co. moved to the top of the heap. Of the nearly $3.5 billion in volume that Jefferies brought to market, $898.5 million, or about 26%, defaulted. Nine out of the 28 junk deals brought to market by Jefferies ended up defaulting. Although CSFB/DLJ was tops in total default volume, the combined entity looks better when the batting averages are scrutinized; 11% defaulted by total principal and 18% by total number of deals.
In the last survey Morgan Stanley led $1.3 billion in deals that subsequently defaulted, while $310 million in deals led by Goldman went the same route. For this year's tables, they jumped to $5.9 billion and $5.4 billion, respectively.
Much of the overall surge in defaults can be attributed to the poor performance of sectors such as telecommunications, which comprised about one-third of all defaults year-to-date. And, the surge is expected to continue. In a recent report, Moody's Investors Service said it expects the trailing 12-month default rate on high-yield bonds to peak near 11% in the first quarter of next year. That would be one percentage point higher than Moody's had forecast before the Sept. 11 attacks, but would still fall short of the July 1991 post-Depression record of 13%. In October, when 18 issuers defaulted on $15.2 billion of bonds, the default rate hit 9.7%, the highest level in close to 10 years, according to Moody's.
Martin Whitman, portfolio manager of the Third Avenue Fund, whose portfolios hold over $600 million worth of distressed debt, says investors in the junk market in 2001 "had to follow down the path of bad financings to its logical end," where the telecoms and Internet credits lay. He sees default risk continuing, especially in the various airline and smaller insurance credits. He says that the entire airline sector is essentially vulnerable to default, with the exception of Southwest Airlines, unless the federal government provides industrywide lines of credit.
Prescott Crocker, senior high-yield portfolio manager at $1.1 billion in U.S. high-yield at Evergreen Investment Management in Boston, says that a theme to watch in respect to defaults for 2002 is the strong dollar, especially relative to the euro. He continues that the expense of U.S. made commodities abroad will force cuspy manufacturers in the steel and mining sectors to seek creditor protection; he declined to cite specific credits he is wary of. When asked about junk underwriting in 2002, he argues that though standards might improve, "underwriters can't do a thing about corporate cash flows." He says that while underwriter history "is definitely a factor" when choosing whether to invest in a new issue, "I see it as a credit by credit decision," noting that he will pass just as easily on a bulge-bracket firm deal as a deal underwritten by a niche player.
John Fenn, head of the $9.5 billion J.P. Morgan Investment Management high-yield portfolio, argues "(underwriter) size does matter" when choosing whether to participate in an underwriting. He says that the sheer manpower a firm like Merrill Lynch or Goldman Sachs can bring to a due-diligence process forces a manager to pay close attention to their deals. Fenn continues that he sees underwriting standards continuing to improve off what he says are "the 1998 lows," and expects a decline in defaults in 2002, despite macroeconomic difficulties.
The study, which is compiled from default lists provided by Moody's and new issuance as listed by Thomson Financial Securities Data, put Lazard Freres at the head of the pack last year: 64% of its total dollar volume defaulting and 55% of its deals. This year, Lazard was not one of the top 15 managers of high-yield deals for the period covered by the survey.
2001 Default By Number Of Deals
2001 Default As % Of Total Principal
Top Managers Of US High Yield Corporate Debt 1998-2001
The Method Behind The Madness
BondWeek limited the study to long-term public bond defaults since 1998, to reflect firms' recent underwriting track record rather than calling them to task for deals sold long ago. Also, three years is near the peak of the historical "hazard rate of default" for corporate bonds, the standard most market professionals use to evaluate the default risk over the life of an issue. Rating agencies and bankruptcy specialists have found that the hazard rate tends to be low in the first two years, peaks around year three, and subsequently begins to fall. Moody's Investors Service analysts explain that if an issuer can sustain payments beyond the third year, the probability of default begins to decrease quickly.
The Turkey Tables were compiled using a list of defaults since 1998 provided by Moody's, which defines a default as any missed or delayed disbursement of interest and/or principal, bankruptcy, receivership, or distressed exchange where the issuer offered bondholders a new security of lesser value. Because a default on one obligation tends to have a knock-on effect for all of an issuer's outstanding obligations, we treat the issuer as a default. Thomson Financial Securities Data provided the new issue data. The firms listed in the survey are the top 15 underwriters of high-yield debt for the period Jan. 1, 1998-Nov. 9, 2001 (see www.bondweek.com for the top 25 managers of high-yield debt for the period of the survey). Data from Thomson excludes sovereign credits, supranationals, federal credit agencies, securitized transactions, split-rated issues, issues that are callable in the first year and a half, issues less than $50 million and issues that mature before 1 1/2 years.