Industry default rates

INDUSTRY DEFAULT RATES MAKE A STRONG CASE FOR DIVERSIFICATION... 

In the short-term, industry default rates are also valuable by highlighting pockets of weakness in the broader market. For example, investors with material exposures to the telecommunication sector either in the United States or in Europe experienced severe losses in 2001 and 2002. For the nine-month period ending September 2002, the European telecommunication sector produced a default rate of 30%. The US rate for the sector was 38.5%. Furthermore, the weighted average recovery... 

EXHIBIT 28.8 Long-Term Industry Default Rates in the United States, 1980-2000 ... 

Recovery rates for individual obligors differ by issuer and industry classification. Rating agencies publish data on the average prices of all defaulted bonds, and generally analysts will construct a database of recovery rates by industry and credit rating for use in modelling the expected recovery rates of assets in the collateral portfolio. 

As noted above, the aggressive industry composition and rating mix of deals that made up the European market s early years was the source of its deep troubles in 2001 and 2002. Approximately 77% and 91% of default volume in 2001 and 2002, respectively, came from the telecommunication and cable sectors (see Exhibit 28.4). The two made up such a disproportionate share of defaults, that the default rate through September 2002 would have been 4.2% excluding the two rather than 24.1%. Not to be ignored, defaults in the United States also reached new heights in 2001 and 2002. The US default rate hit 12.9% on default volume of 78.2 billion in 2001, only to be topped in 2002 with a default tally of 90.5 billion and a new record default rate of 14.3% for the first nine months of the year. 

In general, calculations of industrial emissions rely on default values according to the industrial sector, emission rates, wind velocity and direction, anticipated substance flows through the environment, abatement technologies and wastewater treatment processes (see [114]). Site-specific assessments and local environmental exposure assessments must also account for geographic variability caused by climate, hydrology, geology, and biotic conditions [115]. 

Like Black and Cox s work, the authors find spreads similar to the market spreads. Moreover, they find a correlation between credit spread and interest rate. In fact, they illustrate that firms with similar default risk can have a different credit spread according to the industry. The evidence is that a different correlation between industry and economic environment affects the yield spread on corporate bonds. Then, the duration of a corporate bond changes following its credit risk. For high-yield bonds, the interest-rate sensitivity increases as the time to maturity decreases. 

What is noteworthy is that the recovery rates for telecommunication defaults were nearly parallel in the two markets. They averaged 11.5% and 13.7% of par in the United States in 2001 and 2002, respectively, and 8% and 12% of par in Europe. Since the cable sector in Europe shared many of the same characteristics of the beleaguered telecommunication sector, the average recovery rate on defaulted cable bonds in Europe was also low at 15% of par. (In contrast, recovery rates on cable bonds in the United States were 53% and 41% in 2001 and 2002, respectively.) Considering that the overwhelming volume of defaults in Europe came from the two sectors, it is therefore apparent that the primary reason for the low recovery rates in Europe was this industry concentration. 

To this end, we use the figures of the Swissair financial statements for the year 2000. Swissair defaulted in 2001, but nevertheless this case should document the predictive power of the rating model. Furthermore, an airline is not exactly an industrial company, but due to the problems discussed above an airline model cannot be constructed and the industrial sector seems to have more similarities with the airline sector compared to the utility or telecom sector. 

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