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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
HOUSE_OVERSIGHT_014603