High-yield market guru Martin Fridson’s latest statistical deep dive this week reveals a strange paradox: secured bonds are much more likely than unsecured bonds to end up trading at distressed levels. Fridson, chief investment officer at Lehmann Livian Fridson Advisors, finds that secured bonds account for 40.2% of distressed bonds (bonds trading with risk premiums of at least 10 percentage points over comparable Treasury bonds) outstanding even though they make up just 18.6% of the overall high-yield bond universe. He says 8.82% of outstanding secured issues are currently distressed, versus just 3.04% of senior unsecured bonds, making secured bonds 2.9 times as likely to end up distressed.
Fridson notes that secured bonds still enjoy better recoveries (58.8 cents on the dollar, on average) than senior unsecured bonds (38.9 cents) in the event of a default, but that bonds can suffer big price losses even without a default, as happened in 2007. Here’s Fridson, writing for S&P Capital IQ:
Somewhere there may be investors who do not care one bit if a bond takes a 30-point hickey, as long as they know they will be comparatively well off if the issuer eventually goes bankrupt. Over here in the real world, price declines do matter. Therefore, the goal of high-yield management is not merely to avoid defaults but also to avoid bonds that fall to prices indicative of a high probability of default….