Corporate and RMBS default waves arrive

Both Australian and US default data point to rising stress
Christopher Joye

Coolabah Capital

In the AFR today, I write that our long-projected global default cycle has arrived. In a recent report, S&P comment that 2023 is shaping up as the worst default cycle since the GFC:

This year's global corporate default tally rose to 23 as of Feb. 28--the highest year-to-date tally since 2009--with 15 defaults in February alone, marking the highest monthly total since November 2020. Nearly three-quarters of February defaults came from U.S.-based issuers, and U.S. corporate defaults this year are already over 2.5x higher than the year-to-date 2022 total. U.S.-based media and entertainment issuers led February defaults, but the retail sector leads defaults year to date with seven (over 30% of the global tally). - We forecast the U.S. and European trailing-12-month speculative-grade corporate default rates could rise to 4% and 3.25%, respectively, by December 2023.

Every day we are reading about builders, developers, breweries and other businesses going bust. This gels with the data. We seasonally-adjust ASIC's corporate insolvency data, which climbed to more than 700 insolvencies in February alone relative to the pandemic lows around 200 per month. The concern would be if this trend continued...

In the AFR I note:

Whereas lenders can and do often hide defaults by extending and pretending (restructuring borrowers’ loans so that no formal defaults show up in the official data), the insolvency time-series does not lie. Another data source that does not lie and which we study closely is the monthly arrears reported on the circa $90 billion home loan-backed bonds, known as residential mortgage-backed securities (RMBS). We compute our own compositionally adjusted arrears indices for all Aussie RMBS, which reveals a striking recent increase in the 30 days-plus arrears rate.

In the chart below, you can see our compositionally-adjusted RMBS default rates for banks compared to non-banks. Large non-bank lenders include Liberty, FirstMac, LaTrobe, Pepper, AFG, Resi and others. The first chart is just borrowers who are more than one month behind. The second chart includes the 60 and 90 days arrears rates. You can see a big difference/gap emerging between banks and non-banks' arrears rates.

Beyond the fact that non-banks normally have weaker lending standards than the banks, there is another possible explanation for this emerging gap, which I explain in the AFR:

APRA requires banks to apply a minimum interest rate buffer of 3 per cent when assessing a residential borrower’s capacity to repay a loan. Yet non-bank lenders are not subject to any of these rules. And with much higher funding costs than the banks, and a constrained ability to compete for market share, non-banks may be relaxing their lending standards to capture new clients. There have indeed been reports of non-banks reducing their interest rate buffers to as little as 1 per cent, which might be especially imprudent if central banks are required to embark on a second rate-rising cycle after the widely anticipated pause that should materialise over the next few months.

We can dive into the individual non-banks' RMBS arrears in more detail by looking at the change in their 30+ days arrears rate for different vintages of RMBS issues over time. The charts below summarise that information for FirstMac, Liberty, LaTrobe, Pepper and Resi based on data published by Bloomberg.

Investment Disclaimer Past performance does not assure future returns. All investments carry risks, including that the value of investments may vary, future returns may differ from past returns, and that your capital is not guaranteed. This information has been prepared by Coolabah Capital Investments Pty Ltd (ACN 153 327 872). It is general information only and is not intended to provide you with financial advice. You should not rely on any information herein in making any investment decisions. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. The Product Disclosure Statement (PDS) for the funds should be considered before deciding whether to acquire or hold units in it. A PDS for these products can be obtained by visiting Neither Coolabah Capital Investments Pty Ltd, EQT Responsible Entity Services Ltd (ACN 101 103 011), Equity Trustees Ltd (ACN 004 031 298) nor their respective shareholders, directors and associated businesses assume any liability to investors in connection with any investment in the funds, or guarantees the performance of any obligations to investors, the performance of the funds or any particular rate of return. The repayment of capital is not guaranteed. Investments in the funds are not deposits or liabilities of any of the above-mentioned parties, nor of any Authorised Deposit-taking Institution. The funds are subject to investment risks, which could include delays in repayment and/or loss of income and capital invested. Past performance is not an indicator of nor assures any future returns or risks. Coolabah Capital Institutional Investments Pty Ltd holds Australian Financial Services Licence No. 482238 and is an authorised representative #001277030 of EQT Responsible Entity Services Ltd that holds Australian Financial Services Licence No. 223271. Equity Trustees Ltd that holds Australian Financial Services Licence No. 240975. Forward-Looking Disclaimer This presentation contains some forward-looking information. These statements are not guarantees of future performance and undue reliance should not be placed on them. Such forward-looking statements necessarily involve known and unknown risks and uncertainties, which may cause actual performance and financial results in future periods to differ materially from any projections of future performance or result expressed or implied by such forward-looking statements. Although forward-looking statements contained in this presentation are based upon what Coolabah Capital Investments Pty Ltd believes are reasonable assumptions, there can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements. Coolabah Capital Investments Pty Ltd undertakes no obligation to update forward-looking statements if circumstances or management’s estimates or opinions should change except as required by applicable securities laws. The reader is cautioned not to place undue reliance on forward-looking statements.

Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs $7 billion with a team of 33 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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