Credit Managers See Risk Rising, Not Spreads

Investors grew more pessimistic about the risk of all kinds of debt during the third quarter; paradoxically, however, they became more optimistic about the outlook for credit spreads 

A three-month forecast for a benchmark credit default index declined from negative 26.0 in the second quarter to negative 34.6 in the third quarter, according to a survey by the International Association of Credit Portfolio Managers. The IACPM's aggregate index includes corporate debt, corporate real estate, retail and consumer mortgages.

At the same time, though, the outlook for credit spreads actually improved, from negative 29.0 at the end of June to negative 5.6 in the latest survey, a finding that is almost neutral.

Sentiment improved for investment grade debt and in North America but also in Europe and for high yield debt. For example, the outlook for European high yield debt improved from minus 41.0 in the second quarter to minus 4.9 in the third quarter.

“We’re dealing with almost two realities here,” said Som-lok Leung, the executive director of the IACPM. “On the one hand, survey respondents are clearly worried about rising risk but, on the other hand, they don’t seem to think that spreads will rise in tandem with the risks.”

Survey respondents point to the flood of liquidity being poured into the world’s financial system by central banks, including the U.S. Federal Reserve and the European Central Bank, as the reason the outlook for credit spreads is relatively benign. As long as companies and other borrowers can access low cost financing, most will be able to continue operations and avoid default, at least in the short term.

“The old saying ‘a rolled over loan gathers no loss’ has some validity here,” Leung said. “One of the most crippling problems corporations can face is the loss of their ability to access financing. Market participants now clearly believe the world’s central banks are prepared to meet that challenge and so immediate fear is being held somewhat in check.”

The credit outlook survey is conducted among members of the IACPM, which is an association of credit portfolio managers at 87 financial institutions located in 17 countries in the U.S., Europe, Asia, Africa and Australia. Members include portfolio managers at many of the world's largest commercial banks, investment banks and in-surance companies, as well as a number of asset managers. Members are surveyed at the beginning of each quarter.

Survey results are calculated as diffusion indexes, which show positive and negative values ranging from 100 to minus 100, as well as no change, which is in the middle of the scale and is recorded as "0.0."

Positive numbers signify an expectation for improved credit conditions, specifically fewer defaults and narrower spreads, while negative numbers indicate an expectation of deterioration with higher defaults and wider spreads.

While the outlook for credit spreads has converged to a remarkable degree, the outlook for credit defaults still shows some disparity. The outlook for rising defaults in North America is the lowest of any region, with a reading of minus 18.4, followed by Asia, at minus 23.3. Europe remains the most troubled region, with a score of negative 53.3.