The Outlook for Credit Markets: An Update From Leading Economists
Earlier this week, we had a chance to hear a world-renowned panel of economists present their outlook on credit markets at “New Research and Outlook on Credit Markets”, a conference hosted by S&P Global Market Intelligence.
Here are some highlights from the latest research presented by the panelists.
Where are we in the credit cycle ?
According to Dr. Edward Altman, whose Altman Z-Score is universally used to measure credit default risk, we are 6.5 years into "the benign credit cycle", which historically lasts between 4-7 years. According to his research, default rates typically start rising 2-3 years before a recession. The current default rate is well above the historic average, and accelerating.
Of concern, four important metrics have diverged from their historic averages: default rates, recovery rates, yield spreads on financial securities, and liquidity. Of these, default rates are most important. Dr. Altman expects the default rate to exceed 5.0% for 2016, compared to a historic average default rate of 3.4%.
What global risks are economists most concerned about?
Since the last financial crisis, central banks have pumped lots of liquidity into the system, yet the global economy is still very risky. According to a panel of prominent economists and business leaders, here are some of the biggest risks to watch:
- Banking risk in the Eurozone: While quantitative easing may help troubled economies in the Eurozone, increased leverage and an abundance of “zombie” loans on the books of Eurozone banks threaten financial stability. (Phillip Hartmann, ECB Europe)
- Slower GDP growth in China: GDP growth in China has fallen to the lowest level of the past 25 years, and further declines are forecast. This slowdown will continue to create instability worldwide. (Simon Jin, S&P Global Ratings, Asia)
- Default risk, beyond commodities: The commodities sector continues to be of heightened concern, with companies in metals and mining, oil and gas, construction and infrastructure projects at risk for more downgrades. Emerging markets are also a heightened concern. (Diane Vazza, S&P Global Ratings)
- Other global financial risks: Other concerns include high debt levels worldwide, and the undercapitalization of major U.S. banks, despite financial regulation. (Robert Engle, Nobel Prize winning economist)
Will 2016 be the year the “credit bubble” finally pops?
Credit risks are as high as they were in 2007, before the last financial crisis. While 2016 has gotten off to a rocky start, Dr. Altman noted that it usually takes an unexpected catalyst to trigger a crisis in the real economy. While no one can predict the specific cause -- continued stress in BRIC countries (especially China), the election, or some other trigger -- he expects some as yet unknown event to trigger an acceleration of defaults into the double digits within the next 12 months.
In light of credit market trends, what is the advice for credit professionals?
Conditions are primed for more difficult credit markets. Default rates are rising. Liquidity is diminishing for highly leveraged companies, and more companies will have trouble meeting debt payments. Global markets are risky, and the U.S. economy is not especially robust. For all of these reasons, more bad debts can be expected.
It’s time for financial professionals to be even more cautious. Reduce your company’s risk exposure, and monitor credit customers more closely. Adjust credit limits lower as credit scores decline, ask for more collateral, and rely on more timely information as the cycle changes.
To Hear More ...
Financial professionals have long relied on Dr. Altman’s research to understand credit market trends. For Dr. Altman's research on debt cycles and his view of coming trends, listen to the replay of our March 2016 webinar with him:
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