Fitch: Mid-cap company default rates lower, less volatile than large-cap companies

By Caroline Salls

Pittsburgh, Nov. 15 - U.S. default rates for mid-cap companies were found to be less volatile and lower in high-default periods than those of large-cap companies, according to a new study conducted by Fitch Ratings' credit market research group in collaboration with Edward Altman, director of New York University's Credit and Debt Markets Research.

According to the report, as the number of high-yield and distressed debt investors grew and the size of these markets approached $1 trillion, the number of strategies employed by these investors also multiplied.

The study said a strategy that has become increasingly popular in recent years is the investment focus on mid-cap companies.

Mid-cap companies were defined as firms with up to either $250 million or $500 million in public bonds outstanding.

The study looked at the default behavior of mid- and large-cap companies during stress and non-stress periods and examined the volatility of default and loss rates for the two categories over a credit cycle.

The study covered a five-year sample period of 2000 to 2004, which included two high-default years, two average-default years and one relatively low-default year, and found that while the average default rate of large-cap companies is only slightly greater than that of mid-caps in the sample, the rate differences were sensitive to whether the overall annual default rate on high-yield bonds is relatively low or high.

In high-default periods, default rates of large-cap companies were significantly greater than those of mid-caps, the release said. In addition, when default rates were low overall, mid-cap companies appeared to have higher default rates.

The overall volatility of default rates was found to be greater for large-cap companies.

The study also found that one of the key ingredients of any investment strategy, especially in terms of its risk and return attributes, is the expected default rate on the underlying portfolio securities.

"The study offers empirical evidence that smaller speculative-grade companies may be less risky than larger companies during high-stress periods and more risky during benign periods," Fitch's Mariarosa Verde said in the report.

"Results on recovery rates and loss given default were also consistent with the mid- versus large-cap default rate patterns."

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