Corporate loan portfolio managers in Europe, North America and Asia expect rising default rates in the next 12 months, according to the International Association of Credit Portfolio Managers' latest quarterly credit outlook survey.
Of the IACPM member institutions that took part in the survey, published in January 2023, 91% expected corporate defaults to increase in Europe in 2023, 88% said defaults would increase in North America, and 68% thought they would rise in Asia. The survey, calculated as a diffusion index, didn't predict the scale of the defaults.
Rising interest rates, which will affect borrowers when loans are renewed, is propelling defaults. The IACPM's
The consensus among survey respondents is that there could be defaults later in 2023 or perhaps even later.
"It's still early in the cycle and it's taking time for defaults to rise. We may not see the full impact of higher interest rates until the end of 2023," Leung said. Securities that hold underlying retail mortgage assets will be impacted by defaults as credit spreads widen, he told Asset Securitization Report.
Credit portfolio managers are predicting defaults even though financial markets appear to be pricing in an easier interest rate environment in the second half of 2023. In addition, credit portfolio managers expect wider global credit spreads in the first quarter of 2023. Sixty two percent of respondents expect credit spreads to widen on North American investment grade debt in the next three months, while 74% believe spreads will widen on North American high yield debt.
According to the IACPM, credit spreads narrowed recently in Europe. The IACPM's three-month credit spread outlook index for European investment grade debt was minus -41.4 in December 2022, an improvement from negative -64.5 in Q3 2022, while the outlook index for European high yield Debt rose to minus -51.9 from negative -66.7.
The ending of negative interest rates in Europe could be the reason, Leung said. However, he warned that the economic climate in Europe is worse than in the U.S., with the war in the Ukraine affecting energy credits, and the likelihood that the U.K. is already in a recession.
The IACPM's three-month credit spread outlook index for CDX North America Investment Grade five-year debt deteriorated from minus -40.6 in September 2022 to negative -51.7 in December. During the same period, the spread for CDX North America high yield five-year debt worsened from minus -59.4 in September to negative -66.7 in December.
IACPM board members are more optimistic about prospects for North America than they are about Europe, with some allowing for the possibility of a soft landing in the U.S., Leung said. They think it is possible that a U.S. recession could be postponed until 2024, which might create some disruption in financial markets, but would give corporations more time to strengthen their balance sheets.
Leung warned that the leveraged loan sector is vulnerable to defaults. "Leveraged loans are the higher risk portion of the loan market, so this is where the stress is typically seen first," he said.
