Direction of equity credit markets
Direction of equity markets. The current state of the equity market has an effect on default rates because it determines asset values, investor’s sentiment towards risky assets and the accessibility of capital markets for companies.
Age effect of bonds. The likelihood of payment default by a bond issuer can change with decreasing time to maturity. At the time of issuance, the new issuer has abundant cash and payment default is easily avoided. In addition it is quite common to put some restricted cash from the issuance into an account to cover the first 3–4 coupon payments. Over time the “hazard rate” grows as cash reserves gained through the bond issue are used. The critical period is reached when the success of the firm is least certain and the hazard rate is at a maximum. However, after corporate plans are successfully implemented and sufficient profit has been generated to offset debt, the critical phase is past and the likelihood of payment default declines rapidly. Several empirical studies show that the critical time after first issues is approximately 3 years after issuance for B-rated bonds and climbs to approximately 4 years for BB-rated bonds. The amount of defaults drops significantly after the critical period of the first 3–4 years is survived by the issuer.
Quality of new issue volume. An important measure for the quality of the high-yield market is the percentage amount of new issuance being used to refinance debt. During periods of balance sheet repair (1990–93 and 2001–03) the percentage of total new issue volume will reach high levels.