It's Not Over until the Analyst Sings
August 26, 2009
A majority of economists polled by The Wall Street Journal recently agree the recession is ending, and now we’re beginning to hear that the worst has come and gone from analysts focused on the corporate credit markets as well.
Looking at the telltale signs of the past few months—spreads tightening, prices climbing, deals on the primary markets—some might wonder why you need an analyst to confirm what you already know.
But analysts (especially rating agency types) act sort of like leveraged finance hall monitors. Long before the market starts to fail, they’re lurking in the corridors ready to hand out lack-of-covenant demerits. Likewise, long after investors are hanging out in the alley, high on 40% returns, and bankers are syndicating bonds like lunch ladies passing out milk cartons, analysts will remain in the hall, vigilantly posting gloomy reminders about default rates.
So the fact that both Standard & Poor’s and Fitch Ratings this week issued reports, carefully worded as they may be, saying that the corporate credit markets have seen the worst they’re going to see does seem worth noting.
Fitch cites new debt volume as one reason for optimism. In the second quarter of 2009, the volume of new high yield bonds increased to $52.1 billion from $24.9 billion in the first quarter, a 109% increase. Meanwhile, the volume of new leveraged loans increased by 117%, with a total of $68.4 billion issued in the second quarter compared with $31.6 billion in the first. (Though institutional loans represented only 20.4% of the leveraged loan market in the second quarter, compared with 67% in the first quarter of 2007, when the percentage was at its highest point.)
For their part, S&P analysts point to tightening spreads and the rate of downgrades, which has been declining since March, the worst month in the agency’s history in terms of how many companies were downgraded compared to those upgraded or given a stable outlook. They also note that defaults have “cleansed” the ratings pool of its most vulnerable entities.
But the hall monitors are quick to blow the whistle on even themselves.
The S&P analysts point out that more than a quarter of speculative-grade borrowers remain at serious risk of breaching their covenants over the next six months. And while loan issuance has picked up, the outlook remains dim for the weakest-rated companies to access capital, as most CLOs remain relatively inactive compared to a few years ago.
“Although the worst is likely behind us,” the S&P analysts said, “it would be a mistake to infer that we are permanently out of the danger zone.”
In other words: No running in the halls.