Are You Prepared for a Credit Downturn? A Conversation with Dr. Edward Altman

Transcription

1 Are You Prepared for a Credit Downturn? A Conversation with Dr. Edward Altman

2 Agenda Introduction & Housekeeping Keynote: Are We in a Credit Bubble? Q&A 2

3 Welcome! Dr. Edward Altman Professor of Finance NYU Stern School of Business Pat McParland SVP, Marketing CreditRiskMonitor 3

4 Housekeeping Can also ask questions via All attendees will receive: Paper Recording Copy of slides 4

5 What we ll cover today What is happening in the credit markets? Are we in a credit bubble (and what does that mean)? Is it about to burst? What would the impact be on you, your customers and your vendors when it does? 5

6 Keynote Presentation

7 Credit Markets: Is It a Bubble? Dr. Edward Altman NYU Stern School of Business Credit Risk Conditions Update CreditRisk Monitor July 29,

8 Is It a Bubble? Or, Just Opportunistic Debt Financing? Focus on Default Rates in Credit Markets Length of Benign Credit Cycles Coincidence with Recessions: U.S. & European Scenarios Comparative Health of High-Yield Firms (2007 vs. 2012/2014) High-Yield and CCC New Issuance LBO Statistics and Trends Liquidity Concerns (Markets & Dealers) Potential Downgrades Far Exceed Upgrades (S&P) as of Beginning of 2015 Large Increase in the Distress Ratio Possible Timing of the Bubble Burst 8

9 Historical H.Y. Bond Default Rates Straight Bonds Only Excluding Defaulted Issues From Par Value Outstanding, (US$ millions), (7/15)) Year Par Value Outstanding a ($) Par Value Defaults ($) Default Rates (%) 2015 (7/15) 1,595,839 25, ,496,814 31, ,392,212 14, ,212,362 19, ,354,649 17, ,221,569 13, ,152, , ,091,000 50, ,075,400 5, ,600 7, ,073,000 36, ,100 11, ,000 38, ,000 96, ,000 63, ,200 30, ,400 23, ,500 7, ,400 4, ,000 3, ,000 4, ,000 3, ,907 2, ,000 5, ,600 18, ,000 18, ,258 8, ,187 3, a Weighted by par value of amount outstanding for each year. Year Par Value Outstanding* ($) Par Value Defaults ($) Default Rates (%) ,557 7, , , , , , , , , , , , , , , , , Arithmetic Average Default Rate (%) Standard Deviation (%) 1971 to to to Weighted Average Default Rate (%)* 1971 to to to Median Annual Default Rate (%) 1971 to Source: Author s compilation and Citigroup/Credit Suisse estimates 9

10 Default Rates on High-Yield Bonds Quarterly Default Rate and Four-Quarter Moving Average (2Q) 6.0% 16.0% 5.0% 14.0% 12.0% Quarterly Default Rate 4.0% 3.0% 2.0% 10.0% 8.0% 6.0% 4.0% 4 - Quarter Moving Average 1.0% 2.0% 0.0% 0.0% Quarterly Moving Source: Author s Compilations 10

11 Historical Annual European High-Yield Default Rates 20% 18% 17.28% 33.91% 16% 14% 12% 10% 8% 12.43% 6.56% 6% 4% 2% 2.35% 2.60% 1.20% 1.97% 0.97% 0.53% 1.00% 1.60% 1.06% 3.20% 0.97% 0.70% 1.02% 0.86% 0% Default Rate Q15 Note: 1Q15 is LTM Source: Credit Suisse 11

12 Historical Default Rates and Recession Periods in the U.S. High-Yield Bond Market ( (2Q)) 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Periods of Recession: 11/73-3/75, 1/80-7/80, 7/81-11/82, 7/90-3/91, 4/01 12/01, 12/07-6/09 *All rates annual, except 2Q 2015 which is the LTM. Source: E. Altman (NYU Salomon Center) & National Bureau of Economic Research 12

13 6/1/2007 7/27/2007 9/21/ /16/2007 1/15/2008 3/11/2008 5/6/2008 7/1/2008 8/26/ /21/ /16/2008 2/12/2009 4/9/2009 6/4/2009 7/30/2009 9/24/ /19/2009 1/18/2010 3/15/2010 5/10/2010 7/5/2010 8/30/ /25/ /20/2010 2/14/2011 4/11/2011 6/6/2011 8/1/2011 9/26/ /21/2011 1/18/2012 3/14/2012 5/9/2012 7/4/2012 8/29/ /24/ /19/2012 2/15/2013 4/12/2013 6/7/2013 8/2/2013 9/27/ /22/2013 1/21/2014 3/18/2014 5/13/2014 7/8/2014 9/2/ /28/ /23/2014 2/19/2015 4/16/2015 6/11/2015 YTM & Option-Adjusted Spreads Between High Yield Markets & U.S. Treasury Notes June 01, 2007 July 10, 2015 Yield Spread (YTMS) 600 OAS YTMS = 540bp, OAS = 545bp Sources: Citigroup Yieldbook Index Data and Bank of America Merrill Lynch. Average YTMS ( ) Average OAS ( ) 12/16/08 (YTMS = 2,046bp, OAS = 2,144bp) 2,200 2,000 1,800 1,600 1,400 1,200 1, /10/15 (YTMS = 471bp, OAS = 497bp) /12/07 (YTMS = 260bp, OAS = 249bp) 13

14 Comparative Health of High-Yield Firms (2007 vs. 2012/2014) 14

15 Z-Score Component Definitions and Weightings Variable Definition Weighting Factor X 1 Working Capital 1.2 Total Assets X 2 Retained Earnings 1.4 Total Assets X 3 EBIT 3.3 Total Assets X 4 Market Value of Equity 0.6 Book Value of Total Liabilities X 5 Sales 1.0 Total Assets 15

16 Z Score Model for Manufacturers, Non-Manufacturer Industrials; Developed and Emerging Market Credits Z = 6.56X X X X X 1 = Current Assets - Current Liabilities Total Assets X 2 = Retained Earnings Total Assets X 3 = Earnings Before Interest and Taxes Total Assets X 4 = Book Value of Equity Total Liabilities 16

17 Average Z-Score by S&P Bond Rating Rating Average Z-Score Standard Deviation AAA AA A BBB BB B CCC D Source: E. Altman and E. Hotchkiss (2006), Corporate Financial Distress and Bankruptcy, John Wiley & Sons, pp.247/

18 Comparing Financial Strength of High-Yield Bond Issuers in 2007& 2012/2014 Year Average Z-Score/ (BRE)* Median Z-Score/ (BRE)* Average Z -Score/ (BRE)* Median Z -Score/ (BRE)* (B) 1.81 (B) 4.58 (B+) 4.61 (B+) (B) 1.59 (B) 4.60 (B+) 4.60 (B+) (B+) 1.80 (B) 4.67 (B+) 4.56 (B+) Difference in Means Test (2007 vs. 2012/2014) Model Average Difference (2012/2014) Number of Firms Z-Score Standard Deviation (2007/2012/2014) Z -Score t-test (2012/2014) Significance Level (2012/2014) Significant at.05? (2012/2014) Z-Score -0.23/ / 1.15/ / %/9.70% Yes /No Z -Score +0.02/ / 2.07/ / %/28.78% No/No *Bond Rating Equivalent Source: Authors calculations, data from Altman and Hotchkiss (2006) and S&P Capital IQ. 18

19 Debt/EBITDA & Net Debt/EBITDA: U.S. High-Yield (HY) and Investment Grade (IG), (Median Levels, *) Debt/EBITDA HY Debt/EBITDA IG Net Debt/EBITDA HY Net Debt/EBITDA IG BB- (1,086 obs.) B+ (781 obs.) BB+ (1,126 obs.) BB- (796 obs.) BBB (837 obs.) BBB- (872 obs.) BBB+ (860 obs.) BBB (876 obs.) *Bond Rating Equivalents (BRE) based on Aggregate S&P Statistics Sources: S&P Capital IQ and Ratings Direct and NYU Salomon Center calculations. 19

20 Debt/Debt + Equity & Debt/MV Equity : U.S. High-Yield (HY) and Investment Grade (IG), (Median Levels, ) Debt/Debt + Equity HY Debt/Debt + Equity IG Debt/MV Equity HY Debt/MV Equity IG BB (1,280 obs.) BB- (875 obs.) BBB (978 obs.) BBB- (1,001 obs.) 0.60 (711 obs.) (878 obs.) (705 obs.) (747 obs.) Sources: S&P Capital IQ and Ratings Direct and NYU Salomon Center calculations. 20

21 EBITDA/Interest Expense : U.S. High-Yield (HY) and Investment Grade (IG), (Median Levels, ) EBITDA/Int. Expense HY EBITDA/Int. Expense IG BBB (863 obs.) BBB- (841 obs.) B+ (1,196 obs.) BB- (821 obs.) Sources: S&P Capital IQ and Ratings Direct and NYU Salomon Center calculations. 21

22 Distribution of Credit Ratios for U.S. High-Yield Bonds, (2007 vs. 2014) Debt/EBITDA EBITDA/Interest Expense 2014 BRE 2007 BRE 2014 BRE 2007 BRE 10% 1.36x A+ 0.87x AA+ 1.03x CCC 0.91x CCC 20% 2.23x BBB 1.75x A- 1.93x B- 1.59x CCC+ 30% 2.90x BB+ 2.40x BBB 2.55x B 2.05x B- Decile 40% 3.56x BB 3.07x BB 3.36x B+ 2.57x B 50% 4.43x B+ 3.84x BB- 4.14x BB- 3.24x B+ 60% 5.05x B+ 4.70x B+ 5.23x BB 4.21x BB- 70% 5.94x B 5.70x B 6.64x BBB- 6.06x BB+ 80% 7.08x CCC+ 7.01x B- 9.84x BBB+ 9.07x BBB 90% 10.16x CCC- 9.38x CCC x AA x AA Sources: S&P Capital IQ and Ratings Direct and NYU Salomon Center calculations. 22

23 U.S. & European High-Yield Bond Market: New Issuance ($ millions) (2Q) 300, , , , , ,762.7 New Issuance ($ millions) 200, , ,000 50, , , , , , , , , , , , , , , , , , , , , Q15 2Q15 U.S. Europe Source: Bank of America Merrill Lynch 23

24 U.S. & European High-Yield Bond Market: CCC Rated New Issuance (%) (2Q) 40% 37.4% New Issuance Rated CCC (%) 30% 20% 10% 29.8% 21.7% 19.3% 19.2% 18.1% 3.0% 17.4% 15.3% 11.5% 11.6% 11.0% 8.0% 6.8% 3.8% 25.9% 21.3% 18.2% 16.7% 16.3% 15.3% 15.2% 13.4% 10.6% 9.0% 7.8% 6.2% 6.1% 5.1% 5.8% 4.5% 3.5% 3.1% 0% n/a Q14 2Q14 3Q14 4Q (2Q) 1Q15 2Q15 U.S. Europe Source: Bank of America Merrill Lynch 24

25 New Issues Rated B- or Below, Based on the Dollar Amount of Issuance 70.00% ( (2Q)) 60.00% 51.25% 50.00% 40.00% 30.00% 20.00% 10.00% 40.75% 39.06% 33.57% 32.97% 33.00% 30.41% 29.55% 27.27% 23.35% 21.48% 19.40% 18.16% 14.02% 13.73% 14.16% 31.56% 31.95% 29.62% 29.22% 29.19% 26.73% 27.04% 26.13% 21.38% 12.13% 24.52% 22.88% 21.02% 0.00% Source: S&P Capital IQ LCD 25

26 Mortality Rates by Original Rating All Rated Corporate Bonds* Years After Issuance *Rated by S&P at Issuance Based on 2,847 issues AAA Marginal 0.00% 0.00% 0.00% 0.00% 0.01% 0.02% 0.01% 0.00% 0.00% 0.00% Cumulative 0.00% 0.00% 0.00% 0.00% 0.01% 0.03% 0.04% 0.04% 0.04% 0.04% AA Marginal 0.00% 0.00% 0.22% 0.08% 0.02% 0.01% 0.01% 0.01% 0.02% 0.01% Cumulative 0.00% 0.00% 0.22% 0.30% 0.32% 0.33% 0.34% 0.35% 0.37% 0.38% A Marginal 0.01% 0.03% 0.13% 0.14% 0.11% 0.07% 0.02% 0.26% 0.08% 0.05% Cumulative 0.01% 0.04% 0.17% 0.31% 0.42% 0.49% 0.51% 0.77% 0.85% 0.90% BBB Marginal 0.34% 2.38% 1.28% 1.01% 0.51% 0.23% 0.27% 0.15% 0.15% 0.35% Cumulative 0.34% 2.71% 3.96% 4.93% 5.41% 5.63% 5.88% 6.03% 6.17% 6.50% BB Marginal 0.95% 2.03% 3.90% 1.97% 2.35% 1.53% 1.47% 1.13% 1.45% 3.15% Cumulative 0.95% 2.96% 6.75% 8.58% 10.73% 12.10% 13.39% 14.37% 15.61% 18.27% B Marginal 2.86% 7.74% 7.86% 7.81% 5.71% 4.46% 3.56% 2.09% 1.77% 0.76% Cumulative 2.86% 10.38% 17.42% 23.87% 28.22% 31.42% 33.86% 35.24% 36.39% 36.87% CCC Marginal 8.15% 12.44% 17.92% 16.35% 4.68% 11.53% 5.45% 4.86% 0.69% 4.30% Cumulative 8.15% 19.58% 33.99% 44.78% 47.37% 53.43% 55.97% 58.11% 58.40% 60.19% Source: Standard & Poor's (New York) and Author's Compilation 26

27 Maturity Profile of Leveraged Debt As of 12/31/14 $ (Billions) Bonds Institutional Loans Source: S&P Capital IQ LCD 27

28 Purchase Price Multiples Purchase Price Multiple excluding Fees for LBO Transactions 14x 12x x 8x 6x x 2x N/A 0x (# obs.) 1998 (90) 1999 (133) 2000 (116) 2001 (51) 2002 (40) 2003 (66) 2004 (127) 2005 (134) 2006 (178) 2007 (207) 2008 (69) 2009 (23) 2010 (78) 2011 (87) 2012 (97) 2013 (95) 2014 (136) 1H15 (65) 2Q15 (33) Public-to-Private All Other Source: S&P Capital IQ LCD 28

29 Average Total Debt Leverage Ratio for LBO s: Europe and US with EBITDA of /$50M or More 7.0x x 5.0x 4.0x x 2.0x 1.0x 0.0x H15 Europe US Source: S&P Capital IQ LCD 29

30 LBO Statistics & Ratios: 2007 vs (with Update for 1H15) M&A/LBO as a % of Total Issuance Purchase Multiple Debt to Inception EBITDA to Cash Interest Equity Contribution H15 62% 41% 40% x x x 6.2x 6.0x 5.8x 2.1x 3.3x 2.8x 31% 38% 40% Source: Guggenheim Investments and S&P Capital IQ 30

31 Share of Large LBOs with Leverage More than 7x* Q % 30% 25% 20% 15% 10% 5% 0% N/A N/A H 15 2Q 15 * Issuers with EBITDA >$50mm. Source: S&P Capital I.Q. 31

32 Lenders Leave the Lite On Q

33 Q&A

34 To ask questions Can also ask questions via All attendees will receive: Paper Recording Copy of slides 34

35 Thank You! Our next webinar is August 26 Don Burrelle, Global Credit Manager of Schlumberger Follow us: 35

36 Thank You!