Defaults are rising for smaller borrowers and some larger ones, according to the latest quarterly credit outlook survey from the International Association of Credit Portfolio Managers (IACPM), an association of 144 financial institutions in 32 countries.
The IACPM calculates its quarterly survey is as a series of diffusion indices, reflecting the number of respondents with negative or positive outlooks. The latest results are based on IACPM member views surveyed in early July 2024.
Members expressed an increased expectation of credit defaults in the next 12 months, sending the IACPM Aggregate Credit Default Index to minus -44.1 in June 2024 from negative -36.5 in March 2024.
Transportation, especially trucking, automotive, healthcare, and commercial real estate, including office buildings and senior housing, are the sectors most affected, survey respondents indicated.
The IACPM survey results are in line with Fitch Ratings' view. The ratings agency's Top Market Concern Loan list – comprising companies most likely to experience stress in the next 12 to 24 months – totaled $79.9 billion across 74 issuers at the start of June, up from $72 billion across 72 issuers in the prior month.
"Interest rates have stayed higher for longer," noted Som-lok Leung, the IACPM's executive director, "and borrowers are beginning to feel the pinch, alongside the difficulties posed by continuing inflation."
Other factors driving the negative outlook include wars in Ukraine and the Middle East, concerns about upcoming elections in the U.S., and election results in the U.K., France, India, and the European Union, the IACPM said.
Elizabeth Han, a senior director at Fitch Ratings, expects that corporate defaults will rise this year, but will not reach the levels seen during the great financial crisis of 2008-2010.
For consumer mortgages, 54% of IACPM survey respondents expected higher default rates over the next 12 months versus 47% in March 2024. For commercial real estate, the June expectation of default was 61% versus 60% in March.
The higher risk of default is affecting credit spread expectations for corporate debt, with the survey revealing a more negative spread outlook for North American and European investment grade 5-year loans in June than in March 2024.
The three-months credit spread outlook for North American Investment Grade Debt 5Y was negative -23.5 in June, compared with positive 11.4 in the survey at the end of March 2024. For CDX North America High Yield 5Y, the spread outlook fell from negative -15.9 to negative -52.9 over the same period.
In Europe, the outlook for spreads on ITraxx Europe 5Y deteriorated from negative -15.4 in March to negative -42.9 in the latest survey. Meanwhile, the spread outlook for iTraxx Europe Crossover 5Y fell from negative -25.6 to negative -42.9.
Despite holding negative views on defaults and spreads, portfolio mangers thought borrowers were doing much better than first expected after recent interest rate rises, Leung reported. "When we asked the IACPM board members at our recent board meeting, they said that they are broadly seeing some defaults come in but that it is much better than they expected. They were preparing for something worse, but it has not been that bad," he told Asset Securitization Report.
Mike Nowakowski, head of structured products at Conning, holds a similar view. "In the underlying collateral of CLOs, defaults have picked up to some degree, along with ratings degradation, but not nearly to the scale that many investors had feared," he said.
Leung sees some of the deterioration in outlook since March as a correction to the more positive credit spread outlook at that time. That outlook was due to the expectation of aggressive rate cuts by the Fed, which persistent inflation has delayed, Fitch's Han said.
Taking out the anomalous improvement in March 2024, the longer-term view is that the spread outlook has been improving since June 2022, Leung noted. The IACPM's 12-months corporate credit default outlook index displayed the same pattern, which shows an improvement since June 2022, but a correction since March.
A further sign of optimism is that, for the first time in several quarters, a substantial majority of IACPM survey respondents are not expecting recessions to occur in the U.S., the EU, the U.K. or among most countries in the Asia-Pacific region. In June, Fitch also raised its forecast for 2024 world growth in its latest Global Economic Outlook report.
