Exhibit 85: Moody’s Liquidity Stress Index and Default Rates
Leading indicators suggest the path of defaults for high yield is lower.
Index (%) 25
Trailing 12-Month Rate (%) r 16
Composite Liquidity Stress Index SSS Speculative-Grade Issuer-Weighted Default Rate (Right)
a Ua} U
20
2002 2004 2006 2008 2010 2012 2014 2016
Data through November 30, 2016. Note: Moody's Liquidity Stress Indexes fall when corporate liquidity appears to improve and rise
when it appears to weaken. Source: Investment Strategy Group, Moody’s.
Exhibit 86: Cumulative US High Yield Debt Maturity by Year
Less than 10% of existing debt matures in the next two years.
Cumulative Maturity (%)
100 BHigh Yield Bonds m™ Bank Loans
100 100
90
80
70
60
Weg — io , =
2017 2018
2019
2020 2021 2022 = 2023 or later
Data as of December 31, 2016. Source: Investment Strategy Group, JP Morgan.
experiencing liquidity problems or are at risk of breaching financial covenants. As seen in Exhibit 85, Moody’s composite Liquidity Stress Index (LSI) began to deteriorate in advance of previous default cycles. Third, the commodity sectors of the high yield universe—which collectively generated a staggering 85% of last year’s defaults—are recovering along with oil prices. Keep in mind that the par-weighted default rate excluding these sectors was just 0.5% last year, a fraction of the 3.2% long-run average.” Finally, our default model—which incorporates the leading characteristics of the Federal Reserve’s Senior Loan Officer Opinion Survey and the percentage of distressed bonds—is projecting 2-3% par-weighted defaults in the year ahead.
Other factors corroborate our low-default view. As seen in Exhibit 86, there is very little refinancing
We think the strong fundamentals
underpinning US corporate high yield
still warrant an overweight, though
returns are almost certain to be more
modest going forward.
risk, given that less than 10% of existing debt matures in the next two years. Of equal importance, interest coverage stands near all-time highs today, in stark contrast to the period preceding the financial crisis (see Exhibit 87). This point is further illustrated by Exhibit 88, which shows that today’s high yield universe is much healthier than the pre- crisis cohort, regardless of measure. Keep in mind that low-rated CCC bonds represented just 8% of high yield issuance last year, a 14-year low."
We also note that high yield may be a better interest rate hedge than many investors realize. Consider that during unexpected interest rate backups in the past, high yield has generated a positive return 69% of the time and a return that exceeded investment grade fixed income 85% of the time (see Exhibit 89). This last point is important, as our high yield overweight is funded out of investment grade fixed income. High yield’s hedging qualities were apparent last year, as the asset class appreciated nearly 7% in the second half of the year despite an increase in Treasury yields of more than 100 basis points. Although we assume that any further increase in 10-year Treasury rates this year will not be offset by high yield spreads, this historical relationship
suggests that may be overly conservative.
70 | Goldman Sachs | JANUARY 2017
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