2022 UBS-AM Default study

This paper examines our default outlook for 2022, expectations for rising stars and fallen angels and concludes with our total return forecasts for the year.

Within Asia ex-Japan HY, the real estate sector is an outlier at a 28% expected default rate, mostly emanating from China. Our view is credit losses from potential defaults within the sector are already largely reflected in current pricing. On average we expect recoveries of between 30-40pct of face value with any large variance from our range likely driven by asset quality and government intervention.

After China, Sri Lanka stands out due to persistent weakness in the country’s tourism sector, lack of a fiscal consolidation strategy and a heavy debt repayment schedule in 2022.

Within EMD corporates, we expect Financials to potentially be the largest contributor to total defaults, due in part to the possibility of stress on the Turkish banking system that could impact some of the smaller and weaker Tier-2 banks. Default projections in TMT are also above average driven by concerns over a particular single issuer. Additionally, Real Estate stands out due to pressures in the Chinese property sector.

By geography, Europe’s expected default rate may be driven by the aforementioned stress in Türkiye where the Lira depreciated more than 80% in 2021 amid turmoil at the central bank and the pursuit of unorthodox monetary policy. Aside from the weaker tier-2 banks, Turkish corporates that generate predominately all their revenues from domestic sources but are exposed to liabilities in foreign currency are likely to exhibit some level of vulnerability in 2022. We do acknowledge that some of these risks in Turkish corporates are mitigated by their strong credit profiles, continued access to wholesale capital markets, and experience operating in severely stressed market conditions.

In Emerging Markets, we expect a general trend of rising stars due to strength in the broader commodities complex across all regions.

We see fallen angel risk in certain countries in Latam where quasi-sovereigns and financial institutions have rating profiles directly or indirectly linked to the sovereign rating.

In Asia, continued stress across the Chinese Property sector could lead to an increase in the number of fallen angels; however, we think that state-owned investment grade property developers are going to maintain their credit ratings given expectations of state support.

The Fixed Income Investment Forum remains broadly constructive on high yield and emerging markets overall, and we forecast expected total returns to be positive for these sectors for 2022. Our base case is for Asia HY to generate returns of up to 15%, followed by EM Corporates with just under 2.5% return and the trio of, Short Duration HY, EUR HY and US HY all estimated to gain between 1-2% for the year.