Distressed Debt Investing: Returns and Defaults for 2011

According to CSFB's High Yield Index, the high yield market returned 5.47% in 2011. It felt mighty worse for most investors as spreads widened approximately 150 basis points during the year (many total return investors hedge interest rates which tightened dramatically throughout the year).  In addition, it was simply a very bumpy ride throughout the course of the year.  Here is a chart of the YTD Total Return of the CS HY Index:

Source: Credit Suisse

As you can see, throughout the first half of the year it was a steady grind for investors with spreads hitting a low in the beginning of April fueled by sanguine default outlooks, healthy inflows, and robust appetite of new issues. We all know what happened next (debt ceiling, increased fears over Europe and double dip, etc).

Credit Suisse's "Distressed Securities" category which captures CC, C, and default securities was down 5.46% for the year which is in the range of where I am hearing distressed debt funds performed during the year.

On an individual bond basis, there were a lot of big losers during the years.  Here is a quick snapshot of some of the more liquid names:

Stressed / Distressed Losers of 2011

• General Maritime Senior Notes (Down 92% on the year...ouch)
• Harry & David (Depending on where you have it marked, down ~90%)
• VeraSun Senior Notes (Down 82%)
• NorskeSkog Senior Notes (Down 80%)
• Sino-Forest, all flavors that weren't repaid (Down ~80%)
• NewPage 2nds (Down 80%)
• AMR [certain flavors including the 6.25%] (Down ~75%)
• PMI Senior Notes (Down 75%)
• MF Global various flavors (Down 70%)
• Foxwoods 8.5% (Down 65%)
• EK 7.25% (Down ~65%)
• William Lyon Homes Senior Notes (Down 65%)
• Hawker Subs (Down 63%)
• DirectBuy 2nd Liens (Down 63%)
• Nebraska Book Sub Notes (Down 60%)
• Ahern 9.25% (Down ~55%)
• Aquilex 11.125% (Down ~55%)
• Travelport 11.875% (Down ~55%)

And remember, this is just bonds.  We saw many 2nd lien loans drop precipitously during the year (Quiznos for instance).

Sources: CSFB, JPM, TRACE, Bloomberg

As mentioned above, the default environment for the first half of the year was relatively benign.  Throughout the 2nd half of the year, the number of issuers defaulted ticked up with a number of big name bankruptcies including AMR, Dynegy, and MF Global.  Here is the list of names that defaulted during the year (in alphabetical order):

• AES Eastern Energy LP
• Ahern
• Aquilex (missed payment)
• American Airlines
• Borders Group
• Catalyst Paper (missed payment)
• Constar International
• DEB Shops
• Delta Petroleum
• Dynegy
• Friendly Ice Cream
• General Maritime
• Graceway Pharmaceuticals
• Harry & David
• Nebraska Book
• NewPage
• OPTI Canada
• Perkins & Marie Callender's
• PMI Group
• Real Mex Restaurants
• River Rock Entertainment
• Sbarro
• Summit Business Media
• Trailer Bridge
• William Lyon

According to JPM, the par-weighted default rate for bonds and loan during 2011 was 1.8% and 0.4% respectively, in line with forecasts of a muted default rate for the year. 

This coming year analysts across the street are generally predicting a higher default rate for high yield credit relative to 2011.  Depending on who you talk to, estimates range from the low of 1.5% (JP Morgan) to a high of 4.8% (Goldman Sachs).  On the whole though, it seems that default assumptions for 2012 are higher now than they were a year ago reflecting credit strategists increased pessimistic view on the investment environment.