Capital Markets

Companies to Face Pricier Credit

Bank portfolio managers predict investors will demand higher premiums to buy corporate debt in the third quarter.
Vincent RyanJuly 16, 2008

Companies seeking to raise debt will face higher costs in the next three months as investors demand a larger premium for the risk they take, according to a new survey of credit portfolio managers. The same group of executives at banks and other financial institutions also expect corporate credit defaults to rise in the next 12 months.

The expectation that credit spreads — the difference between the yield on debt securities of a corporate borrower versus that of similar maturity Treasury debt — will widen in the coming months is a sharp change in direction. In the March installment of the survey, which is conducted by the International Association of Credit Portfolio Managers (IACPM), risk managers forecast that spreads for corporate debt would tighten. They did so in the second quarter, in part due to the credit market rally that resulted from the Federal Reserve’s rescue of Bear Stearns.

But “sentiment has clearly changed,” said Som-lok Leung, executive director of the IACPM, in a press release. “Spreads tightened during the spring after widening significantly with the onset of the credit crisis. Now, once again, portfolio managers believe investors will demand wider spreads, partly because managers expect real risk to rise in the form of higher defaults.”

The IACPM credit spread index average hit –69.1 in the June survey, meaning a substantial majority of respondents believe credit spreads will widen. In March, the result was 14.8, indicating a majority of respondents anticipated tighter credit spreads. (The scale runs from –100 to 100.) The outlook for high-yield debt in the U.S. was even gloomier, with the index at -78.7. Survey respondents were slightly more pessimistic about the United States than Europe. The spread index for high-yield credits in Europe, for example, was -58.1.

In addition, the IACPM index that measures the outlook for credit defaults showed that a large majority of portfolio managers believe defaults will increase. The index measure, –79.9, was about the same as the March figure.

The views of credit portfolio managers echo the sentiments expressed this week by Diane Vazza, a managing director at Standard & Poor’s. In a report on inflation risk, Vazza said “the downside of higher inflation is likely to result in compressed corporate margins, as inflation raises input prices without the ability to pass on fully to the end-user amid an economic 
slowdown. Furthermore, rising inflation is likely to apply upward pressure on yields and spreads, and simultaneously lower nominal returns for holders of corporate bonds vis-à-vis other securities that offer a hedge against inflation.”