The Emerging Markets Debt team recently conducted a midyear review of our default estimate for emerging markets high yield (EM HY) corporate debt. We now expect a default rate of 3.4% for fiscal (FY) 2021—a moderate improvement from 3.8% in FY2020, but slightly higher than our original estimate of 3.3% and the 10-year average of 3.0% (range of 0.6 – 5.1%). A key factor affecting our forecast is rising China corporate default risk, offset by an improving outlook for most other EM regions.
Historical EM HY Corporate Default Rate (% notional)
Source: Neuberger Berman (2020 – 21 estimate based on bottom-up analysis), JPMorgan (2011 – 19)
The EM corporate HY default rate stands at 1.6% YTD (as of July 30, 2021). Key defaults have included: (1) China Fortune Land, an industrial park and residential developer in China, which is the largest default in the Asia USD corporate space so far at USD 4.56 billion, and (2) YPF, the Argentine oil and gas company, which conducted a partial distressed exchange as liability management in light of the FX controls the country imposed last year.
We see visible regional and sector shifts in stress, driven by commodities prices and specific domestic policies. As of August 4, 7.6% of the Asia HY corporate universe traded below a cash price of 70, up from 1.6% as of end of 2020, driven by rising volatility in China property and financial sectors. In contrast, stresses in CEEMEA (bonds <70: Dec 20 1.4%, vs. current 0.1%) and Latin America (bonds <70: Dec 20 5.1%, vs. current 2.6%) have eased, supported by an accommodative refinancing environment and broad-based improvement across countries and sectors, particularly in the oil and gas and transport sectors.
In Asia, our regional default forecast has been revised upward to 3.8% for FY2021 (original estimate: 2.7%). Tail risk in China is increasing due to multiple market reforms. Policy tightening is weighing on a handful of sectors: property, as authorities seek to rein in leverage; local government-related entities (GRE), where implicit local government supports are being reconsidered; industrial sectors pressured by environmental targets, and consumer and financial sectors, which face various new guidelines. We believe many of these policies will be good for the China credit market in the long run, but some more leveraged companies may fail in the process. In particular, we see higher risk in the property space and among select industrial names. China appears increasingly willing to allow some big issuers to fail in order to reduce moral hazard, so long as spillover risk is under control. By adopting a market approach on distressed workouts, policymakers are seeking credit differentiation, control of macro leverage and improved capital allocation efficiency. Market tolerance of defaults has improved in light of various landmark default cases over the years. That being said, Evergrande and Huarong, two major Chinese USD bond issuers that have recently come under pressure, are significantly larger in scale than existing default cases. If either of them fails, that would add about 2.5% to the global EM HY default rate, or about 5% to the Asia regional default rate this year. Outside of China, we do not expect major stress or defaults in either India or Indonesia, except in idiosyncratic cases involving smaller issuers. Several Indonesian issuers conducted liability management exercises recently to extend maturities with new bonds or bank loans.
Our CEEMEA and Latin America default forecasts for FY2021 have been reduced to 1.8% and 4.3%, respectively. Strong commodities prices and a reversal of the sovereign default trend from last year offer a supportive operating and refinancing backdrop for corporates. Our team expects commodities’ supply-demand dynamics to remain favorable through year-end; thus, we anticipate relatively low stress in the sector and related regions. Separately, we see declining default risk in Brazilian and Argentine corporates, after numerous preemptive liability and capital structure management exercises conducted by a few previously stressed issuers. While we see a lowered likelihood of default and distressed exchanges for Argentine corporates, we are not ruling them out, as capital control measures remain in place despite an improved refinancing environment. Brazilian airlines have also seen reduced risk, given strong air cargo operations, recovering domestic passenger flow, cost-cutting and refinancing.
Overall, we remain constructive on the EM corporate HY markets for H2 2021 given the relatively benign default outlook, even though our forecast for the year has ticked up marginally.