Shrinking pool of bad debts is a good sign for emerging markets
The pile of distressed debt in emerging markets that ballooned in March is quickly shrinking, suggesting to some investors that fears of a wave of corporate collapses are overblown.
Despite warnings that default rates will rise to double digits, investors have turned more bullish on the riskiest debt sold by companies in markets from Latin America to China, resulting in falling levels of distressed debt.
Since peaking on March 19 at $121.6 billion, the pool of high-yield, emerging-market corporate debt trading at distressed levels has shriveled to $28.6 billion, according to JPMorgan Chase & Co. The spread between high-yield bonds and a broader index of developing-nation debt has tightened 140 basis points over that time.
"The level of hysteria we saw in March for corporates was somewhat unprecedented," said Steve Cook, co-head of emerging markets fixed income at PineBridge Investments, which has $96.2 billion in assets under management. "There will be some weak links, but to say that you're going to see 10% to 12% default rates, we don't see it."
PineBridge expects the default rate for those corporates to reach 3% to 4% by the end of the year, he said.
A global recession caused by the coronavirus lockdown and worsened by a crash in oil prices has heightened the risks corporations won't be able to meet obligations. Moody's Investors Service said this week it expects the default rate to at least triple by the end of the year for speculative-grade companies in Latin America and that it may top 10%. The ratings firm previously said as much as 13.7% of speculative-grade corporate bonds in emerging markets will sour in the year to March 2021. The rate at the end of March was 2.2%.
Yet, high-yield, developing-market debt has gained 15% so far in the quarter starting in April, compared to 12% for high-yield U.S. corporate debt, according to data compiled by Bloomberg.
To be sure, the downturn has taken a toll on the government debt side of emerging markets, with countries including Argentina, Ecuador and Lebanon already defaulting.
The situation is not entirely rosy for companies either, especially if economies recover more slowly than expected. Yet, many corporations went into the downturn with relatively strong balance sheets and have benefited as governments poured stimulus into banking systems and, in some cases, instituted moratoriums on principal and interest payments, said Omotunde Lawal, head of emerging market corporate debt at London-based Barings U.K. Ltd.
Lawal expects a legion of companies to start to benefit when economies do reopen, earning just enough revenue to meet obligations, but not enough to continue cutting debt levels.
"Balance sheets will be weaker and we'll see a growth of zombie corporates," she said. Many companies will "muddle through with a slower path to deleveraging, but it will not cause a spike in defaults."
With many sectors continuing to suffer, notes sold by companies such as Brazilian air carrier Gol Linhas Aereas Inteligentes SA and Chinese property manager China Evergrande Group are still distressed. But the rally has pushed down yields for many bonds that were distressed in March, such as debt from companies as varied as Chilean mobile services company WOM to Mexican concrete giant Cemex SA, according to data compiled by Bloomberg.
Companies across the globe have piled into debt markets since the financial crisis, with the total stock of outstanding bonds reaching $2.4 trillion this year, a four-fold increase from 2009, according to JPMorgan data.
The sheer size of the universe of such debt means even if defaults start to rise, the percentage is unlikely to hit double digits as it did during the financial crisis, PineBridge's Cook said.
"We need to be careful not to compare it to the financial crisis," he said.
