Brexit Contagion Worries Stoke Credit Portfolio Manager Fears

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Credit portfolio managers are expecting deteriorating credit conditions in spreads and defaults in North America and Europe this summer, as the fear over Brexit contagion spreads around the globe.

In particular, 68% of managers worldwide expect to see growing defaults in the European investment-grade space this summer.

However, plenty of other headwinds are also cited as reasons for the stormy outlook, according to a quarterly survey released Thursday by the International Association for Credit Portfolio Managers.

The North American market, while not as directly impacted by Brexit, will still feel ramifications with a similarly high number (59%) of managers forecasting similar problems for the U.S. high-grade corporate default rate.

“There’s a feeling that the credit cycle has been benign for some time,” said Som-Lok Leung, executive director of the IACPM, in an interview with Asset Securitization Report. “Even without the Brexit vote, we would see things looking negative.”

But the clear driver was the UK vote in June on a referendum to leave the European Union, sparking fears of a recessionary global impact. Survey respondents are paying close attention to political backlash, including the possibility of Austria and The Netherlands following the UK’s lead.

The performance of central banks is also driving the expected worsening conditions in the third quarter. The focus appears to be on the banks’ potential stimulus actions. The European Central Bank launched a corporate bond buying program in the spring – an impetus for a revival in the collateralized debt obligation market, many observers believe.

The U.S. Federal Reserve has shown a reluctance to boost interest rates as expected, but with the 10-year U.S. Treasury yields having fallen to record lows, the negative interest rates plaguing Europe’s bonds market could be a possibility domestically, said Leung. “In some ways, ultra-low interest rates are as troublesome as Brexit,” he said, according to a release, since it puts pressure on even the most conservative debt investors, including pension funds to find acceptable terms with long-term or even leveraged debt exposure.

Negative factors the U.S. include continued stagnant energy sector performance, and also the slowing economic growth of China.  

According to the survey, 43% of respondents expect credit spreads to widen in the third quarter in North America, and 63% percent see spreads widening in the leveraged/high yield space. Only 23% in both the IG and high-yield surveys expect spreads to tighten.

While the negative expectations were significant, the IACPM 3 Months Credit Spread Outlook Index actually showed lower levels of negative expectations that the survey taken at the end of the first quarter in March. Calculated in a diffuse spread, the outlook for spreads among North American corporate high-grade firms is at minus (-) 20, and minus (-) 40 for North American junk rated companies. The numbers were worse on March 16, with the three-month credit-spread index at minus (-) 31.6 for investment grade, minus (-) 47.4 for speculative-grade.

(The survey results are presented in a diffusion index, with positive and negative values ranging from 100 to minus (-) 100. Positive numbers present an expectation that managers expect improved credit conditions – fewer defaults and narrower spreads – while negative numbers connate a belief in short-term credit deterioration, meaning higher defaults and wider spreads.).

The survey has been mired in negative numbers for spreads and defaults for the last five quarters.

The end-of-quarter survey is conducted among members of the IACPM belonging to more than 90 financial institutions in 17 countries in the U.S., Europe, Asia, Africa and Australia. Many are portfolio managers of the largest commercial and investment banks, insurance companies and asset management firms.

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