Altman Questions Debt Market Conditions

Chidem Kurdas

The latest research on credit markets was presented this week at New York University’s business school. The conference was held at the appropriately named Paulson Auditorium—as in hedge fund manager John Paulson, graduate of ’78, who gave the school $20 million of the several billions he made betting against the housing bubble.

NYU professor Edward Altman, whose pioneering work on credit and bankruptcies was reputedly of interest  to Mr. Paulson, says he is bullish about the economy but not about debt markets. The spread between high-yield bonds and 10-year Treasury notes is too low for the uncertainties facing us, he says.

Before the credit crisis erupted, Mr. Altman had noticed a similar departure from historical norms: Rates were extremely low for risky debt. In mid-2007 the spread was only 260 basis points, about half the historic mean of 525. From there the spread increased, initially slowly and then faster and faster until it reached a crescendo of 2,000 basis points at the height of the crisis in December 2008.

That was greater than ever before, said Professor Altman. The prior peak for this measure was 1,100 basis points. From the unprecedented high, the spread declined at a fast pace as markets recovered and appetite for risk returned. This volatility pattern was never seen before, he said.

Currently the spread is around 500 basis points after rising in response to the Greek debt turmoil. While not far from the historic average, this is low considering the shakiness of markets and economies, as demonstrated by the European turbulence in the past weeks.

Default rates are another anomaly. The 2008-2009 crisis was so bad that credit experts, including Mr. Altman, expected business defaults to skyrocket—he predicted 13% to 14%, others predicted 15% or even 20%. But defaults remained under 11% in 2009 and have declined in the past year or so, largely because of liquidity pumped in by the Federal Reserve.

Low default rate did not stop distressed securities investors from making good money this year. The Barclay Distressed Securities Index returned 9.52% year-to-date as of the end of April, compared to 4.58% for all hedge fund strategies. Sol Waksman, founder and president of BarclayHedge, says it’s been an excellent environment for buyers of distressed securities, with high-yield bonds gaining faster then investment-grade as investors seek yield.

Risk is back, says Professor Altman. He believes the US recession ended in 2009 but there is the question of what a default rate that was much too low by the standards of past recessions means for the next few years.

Participants at the NYU conference had occasion to refer to Mr. Paulson when discussing mortgages and derivatives. But neither he nor any of his colleagues spoke—Paulson & Co. has a prominent role in the Securities and Exchange Commission complaint recently filed against Goldman  Sachs, though Paulson is not accused of wrongdoing.

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One Response to “Altman Questions Debt Market Conditions”

  1. Repo Credit Lesson from Paulson Auditorium « HedgeFundSmarts Says:

    […] That’s the question in a study by Gary Gorton and Andrew Metrick of Yale University and the National Bureau of Economic Research, presented this month at New York University’s Stern School of Business. The conference was held at an auditorium named after hedge fund manager John Paulson, an alumnus who’s been generous to the school. I’ve wrote previously about another talk, by credit specialist Edward Altman. […]

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