Outlook 2022: Junk defaults end 2021 at record low; light volume forecast in new year

By Cristal Cody

Tupelo, Miss., Dec. 31 – High-yield defaults shrank to new lows in 2021 with defaults expected to remain light in 2022 after a staggering Covid-induced tally in 2020.

“The year 2021 is set to go down in history as the point in time when HY defaults have set their all-time record lows as far back as our data goes for the last 40 years,” BofA Securities, Inc. analysts said in a research note.

As of Dec. 8, the year-to-date U.S. high-yield default rate stood at 0.5% and was “poised to finish just below 2007's record low level,” according to Fitch Ratings.

“The 2021 default volume tallies only $6.9 billion,” Fitch senior director Eric Rosenthal said in a report. “Volume has been especially light during the second half of this year, including experiencing a 103-day stretch with no defaults that exceeded the 90-day record set back in 2007. The lack of default volume contrasts starkly with the $68.1 billion total amassed at this point last year.”

There have been just 10 U.S. high-yield issuer defaults in 2021, with half coming from the energy sector, Fitch said.

Besides energy, no other sector produced more than one default in 2021, according to Fitch.

“Leisure/entertainment has the highest default rate at 3.6% due to Carlson Travel Inc., which totaled $1.1 billion of volume, but the slightly elevated level reflects the sector’s small size,” a Fitch note said. “Energy, the largest sector accounting for 14% of the market, has the next highest rate at 1.5%.”

The U.S. distress ratio of issuers rated BB+ or lower with spreads of over 1,000 basis points over Treasuries increased to 2.6% as of Dec. 6 from 2.3% in the previous month but still well below the 9.7% five-year average, according to a S&P Global Ratings release.

“The distress ratio remains near historical lows despite a record number of U.S. speculative-grade issuers – a sign that market stress in the credit markets is remarkably low,” said Nicole Serino of S&P Global Ratings' Credit Markets Research.

The number of global “weakest links” have dropped over 50% year to date, the lowest since April 2019, S&P said.

“Although issuers rated B- and below constitute over 30% of speculative-grade ratings, the negative bias for issuers rated B- and below has fallen to a record low of 24%, contributing the most to the fall in the number of weakest links,” Serino said.

Reduced 2022 maturities

Financing conditions were accommodating for U.S. junk issuers as 2021 issuance climbed to a new high of $435 billion, S&P said.

During the year, companies reduced speculative-grade maturities through the end of 2022 by 40% to $208 billion, while speculative-grade debt due in 2023-2024 also declined 21%, according to S&P.

“We now see the U.S. trailing-12-month speculative-grade corporate default rate ticking up to just 2.5% by September of next year, up from 2.4% as of September 2021,” S&P said. “But while all indicators imply a slow pace of defaults ahead, we recognize growing risks that, in our pessimistic scenario, could push the default rate to as high as 5.5%.”

Fitch forecasts the year-end 2022 default rate at 1% on the back of robust capital markets access that allowed issuers to push out maturities and shore up liquidity.

Supply chain constraints, inflation and labor markets likely will continue to present challenges for issuers in 2022, but Fitch said it is not anticipated to impact default volume significantly given the overall maturity extension.

Sectors including health care/pharmaceuticals, retail and leisure/entertainment are anticipated to have default rates at 1% or lower in 2022, according to the Fitch report.

The energy default rate is projected to finish 2022 at 1%, which would be the lowest level since 2014.

“This reflects the weaker issuers having already defaulted in 2020, along with higher crude oil prices and renewed capital market interest,” Fitch said.

Moody’s Investors Service expects 2021 to close with a trailing 12-month global speculative-grade default rate of 1.7%.

The rate is expected to stabilize to 1.6% to 1.8% in the first half of 2022 and “gradually rise thereafter” to 2.2% by the end of October 2022, Moody’s said.

Defaults in 2022 are eyed in just a handful of sectors, according to a BofA report.

“Only 4-6 sectors will be responsible for essentially all of projected defaults, with the highest likelihood of restructurings in media, utilities, telecoms, cap goods and a handful of others,” BofA analysts said.

“We think this credit cycle is still in its early stages; likely years ahead of us before conditions are met for the next default wave,” the analysts said. “Overall HY defaults should normalize to 1.7% par-, 2% issuer-weighted. Most sectors will see zero defaults, with only a handful responsible for the residual.”

BofA is projecting zero defaults in BBs and a near-zero rate in B-rated issuers at 0.4%.

“Whatever comes our way in terms of credit losses, is coming from CCCs” at a projected 6.7% rate, the analysts said.

In 2021, CCC defaults dropped to a record low of 2.2% annualized.

“They have previously bottomed out at 2.8% in both 2007 and 2014,” the BofA analysts said.

China-based defaults

A heavy round of defaults is expected from China’s property developer space as missed bond payments mounted in late 2021 from issuers including China Evergrande Group, Kaisa Group Holdings Ltd., Fantasia Holdings Group Co. Ltd., Sinic Holdings (Group) Co. Ltd., China Properties Group Ltd., Modern Land (China) Co. Ltd. and Sunshine 100 China Holdings Ltd.

The high-yield emerging markets space saw a default rate of 2.6% in 2021.

The 2022 Asia default rate is projected at 1.5% to 3% for Asia high-yield issuers, excluding China property companies, and at 31% for the China property space, according to BofA.

“We estimate the default rate on Chinese HY property could vary from 20% to 65% with our base case near 30%,” the BofA analysts said. “Most HY developers will find it hard to refinance their bonds until the market stabilizes and the Chinese [government] introduces meaningful easing measures.”

Moody’s said that Chinese corporate onshore defaults rose by 19% to about $15.4 billion in the first three quarters of 2021 from the year earlier, while offshore defaults rose 28% to about $7.8 billion, surpassing the full 2020 total.

“We expect defaults will continue to rise through 2022, but the number of defaulters and value will remain low relative to the total onshore and offshore bond markets,” Moody’s said. “And we believe Chinese authorities will intervene if they see signs that bond defaults will rise significantly or trigger systemic risk.”

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