Corporate Credit: Defaults, Recoveries, and Ramifications

Abstract

The short-term success of a high-yield bond strategy hinges on the default and recovery rates that materialize. The average of four different default rate prediction models indicates that the 2009 default rate may be the highest in history. Experience shows that high default rates are associated with low recovery rates—the ultimate concern of high-yield bond investors—also known as the loss given default. Although the combination of forecasted high default rates and low recovery rates is not good news for high-yield bond investors in 2009, being prepared may allow investors to better protect their portfolios from already tumultuous markets. Despite record default losses expected in 2009, the high-yield bond market could perform well in 2009 if the general economic picture improves.