Default rates edging lower in July. Favor B-rated €HY vs BBs

With three defaults only in July and a year-to-date figure of 49 defaults, Moody’s High Yield default rate edged lower again in July , to 2.8 % from 3% in the prior month. HY default rates went lower in all the regions, by 2 0 bp in the US (to 3. 37 %) and 14 bp in Europe (to 2.1 9 %) . Meanwhile, d efault-rate forecasts estimated by the rating agency have been slightly revised upwards for the next three months in the US (by 10bp in average, see chart opposite) , as well as in Europe . Nevertheless, the 1-year forward HY default-rate is heading South : more in the US (from 3.4% to 2.2%) than in Europe (from 2.2% to 2.1%), with a bottom being reached in Q1-19 (particularly in Europe) according to the rating agency. Lower default-rate forecasts more than offset the spread-tightening movement observed in €HY during the past month, lead ing to higher spreads net of default risk (see chart opposite) : according to our calculation, € B-rated break-even spread has jumped to 1.9 % (spreads as of 9 th August ), which is very close to its 3 rd quartile over the past 15 years (2%) , i.e a cheap level . This is less the case for € BBs , which break-even spread stands at 1.2% , in line with its 15-year median. Given €BBs are only fairly valued vs default rate, while being more sensitive to the ECB’s QE exit strategy and offering no value compared with $ BBs, we maintain our negative stance on €BBs . On the other hand, w e keep our strong overweight recommendation on B-rated €HY, much cheaper on the spread/default basis than BBs, very attractive vs $ Bs and less dependent from the ECB ’s exit strategy . S ector-wise, Retail has recorded 1 1 defaults so far this year, the highest number among all sectors (one new default in July: House of Fraser ) . By comparison, the Oil&Gas sector is the second most troubled sector with 9 defaults year-to-date, but still showing a huge improvement versus 2017 at the same time (17 defaults) . At 1.42% expected 1-year forward, the default rate in US Oil&Gas should actually be lower than the overall default rate observed for US Corporates (1.9% at end-July).