Risk Management

Portfolio Managers Say Credit Costs Will Rise

After indicating last quarter that U.S. credit conditions were diverging from Europe’s, credit-portfolio managers have a negative outlook on short-...
Vincent RyanJuly 25, 2012

Credit-portfolio managers at banks, insurance companies, and asset-management firms foresee higher credit risk in the United States in the next three months, a change from last quarter’s view that credit conditions were worsening in Europe but improving domestically. If the forecast proves true, its means investors could demand higher premiums on corporate debt, and more indebted companies than previously forecast could default.

The credit managers’ outlook for five-year credit spreads in the United States — for both investment-grade and high-yield credits — turned “sharply negative,” says Som-lok Leung, executive director of the International Association of Credit Portfolio Managers (IACPM), which surveyed its members.

In the United States, the three-month outlook for spreads on investment-grade bonds changed from a positive reading of 15.2 in April to a negative reading of -19.1 at the beginning of July. In Europe the outlook on spreads worsened to -30 from -9.8.

The IACPM survey uses a “diffusion index” to measure credit sentiment. The farther a reading is from zero, either positive or negative, the greater the consensus among portfolio managers that credit conditions will move in a certain direction. A negative number means credit spreads will widen.

The U.S. numbers represent a reversal from the last three quarterly IACPM surveys. Since September 2011, credit managers have forecast a divergence of credit-spread movements between the United States and Europe. Portfolio managers were down on Europe but clearly signaling that they expected spreads to tighten in the U.S. credit markets.

But the slowing economic recovery in the United States, economic softening in China, and the still-unresolved European debt crisis are having an effect on the outlook for credit globally, says Leung.

The credit conditions that portfolio managers foresee actually mirror what happened in the fall of 2008 after the collapse of Lehman Brothers, when markets began to move in lockstep globally. High correlations in the movement of assets and geographic regions make it harder for portfolio mangers to diversify.

The IACPM also asked credit managers about the 12-month outlook for credit-default rates. Views on default rates — across corporate, consumer, and commercial real estate debt — also turned slightly more negative in July.

But portfolio managers don’t expect defaults on corporate debt to move much. Forty-two percent of the IACPM survey respondents said credit-default rates for corporates would rise in the next 12 months, but the same percentage said they would be unchanged. When it came to commercial real estate loans, however, 44% said default rates would rise, while 39% said there would be no change.

On an absolute basis, of course, interest rates on corporate debt remain near historical lows. But borrowing costs have risen slightly in the past few months, according to Diane Vazza, managing director in global fixed-income research at Standard & Poor’s.

In a July 13 report, Vazza said investment-grade spreads rose to 213 basis points at the end of June, up from 196 basis points at the end of March. Speculative-grade spreads rose to 685 basis points from 623 over the same period. The risk premium for high-yielding securities also increased from March to June.

The IACPM survey polled credit managers at 84 financial institutions in 17 countries.