Invesco Bond Income Plus Limited: the high yield default environment

Forecast and realised defaults

The backdrop for the high yield corporate bond market was very supportive in 2021. The high level of bond defaults anticipated in 2020 never materialised. As a result, many issuers were able to refinance their debt and credit spreads narrowed to reflect the limited risk.

New issuance was plentiful and easily absorbed by a market hungry for yield. According to data from JPMorgan, European currency net supply totalled €88.3bn in 2021, eclipsing the previous net record seen in 2020 of €58.1bn.

Defaults lower than expected

In their monthly ‘Default Trends Report’ published in January 2021, Moody’s predicted that the Global high yield default rate would peak at 7.3% and then decline to 4.7% by December 2021.

A year on Moody’s reported that defaults actually peaked at 6.9% in December 2020. They went on to fall steadily through 2021 and the year ended with a global high yield default rate of just 1.7%. This is the lowest realised default rate since early 2008.

This led to some interesting findings:

• There were 54 defaults in 2021, down from 216 in 2020 and 105 in 2019.
• This was the lowest figure since 2011, when 53 defaults were recorded.
• Of the 54 issuers defaulting, 24 were North American, Asia Pacific had 14, Europe 10 and Latin America 6.
• Moody’s report that the Construction & Building sector was the largest contributor to defaults, with 9 (8 from China), followed by Business Services and Oil & Gas with 7 defaults each.

Defaults were spread across payment defaults, bankruptcies and distressed exchanges. A distressed exchange occurs when a company’s creditors agree to restructure its debt, allowing it to survive as a business but with a less onerous debt burden.

Defaults could now creep up

Moody’s forecast the global default rate will now rise, albeit it slowly, from 1.7% to 2.4% at the end of 2022.  This is according to their ‘baseline’ forecast which assumes high yield spreads will widen by around 2% over the year.

Regionally, there’s only limited difference between their year-end forecast for the US at 2.6% and Europe at 2.3%.

In terms of sectors, for the US they anticipate the most defaults to occur in Hotel, Gaming & Leisure (3.5%), Telecommunications (3.2%) and Aerospace & Defence (3.0%).

In Europe they expect Hotel, Gaming & Leisure (4.8%) to also see the most defaults, followed by Containers, Packaging & Glass (2.6%) and High-Tech Industries (2.5%).

Portfolio defaults

Providing a portfolio level percentage default rate is a subjective exercise, and something we tend to avoid. A default could be as mild as a late coupon payment, and ultimately no loss might occur. At the other end of the scale, a bond can suffer large price falls without defaulting. 

A distressed bond can be sold before it defaults and no default reported, yet the portfolio may still have suffered a loss. On the other hand, the portfolio could gain through buying a bond at a distressed level, holding it through a default process and profiting from a successful restructuring of the company’s debt. 

Still, in order to answer the question, there were two issuers held in the Invesco Bond Income Plus Limited portfolio that were listed on Moody’s list of defaulters during 2021 (down from six in 2020). Both of these, Codere and Petra Diamonds, also made the default list in 2020 before successfully restructuring in 2021. 

As stated above, distressed bonds, that are likely to default, can sometimes represent a source of opportunity for us.  Whilst this is not a core area of investing for the trust, it is an area in which the Invesco team has significant expertise in both assessing and managing investments that have become distressed. 

Petra Diamonds is a very good example of this. This is a position the team already had some exposure to at the start of 2020.  As it became apparent that a default was likely, we chose to increase that exposure, but at a ‘distressed price’ of 34.5 USD versus a par price of 100 USD. Our view was that the company should survive but would require a balance sheet restructuring.  

Purchasing bonds at a distressed price of 34.5 USD offered significant upside because we were prepared to follow through with the restructuring, even if it did mean recording a default. March 2021 saw the company successfully restructured.

Bondholders received new bonds and took ownership of most of the existing equity. Although Petra Diamonds cost the portfolio -0.18% in 2020, in 2021 it helped the portfolio gain 0.90%¹. The attribution/contribution figures are estimates and should be used for indicative purposes only. Data cleansing and retrospective information availability may cause changes.

Meanwhile, Codere completed its restructuring towards the end of the 2021, with bondholders receiving the majority of the company’s equity in exchange for a partial debt write-down.  Invesco worked closely with Codere’s management team and advisors as part of this restructuring process.  

Codere added 0.28% to returns in both 2020 and 2021. We anticipate a further improvement in the company’s prospects once it returns to full operations with a refreshed balance sheet and a new capital structure. 

Both companies are examples in which our experience assessing distressed bonds, and working with companies through restructurings, can provide additional returns for the portfolio.