Corporate credit conditions globally are anticipated to continue deteriorating, according to corporate-loan portfolio managers, who when surveyed at the start of 4Q 2022 overwhelmingly anticipated corporate defaults increasing and credit spreads widening.
The International Association of Credit Portfolio Managers' (IACPM) quarterly survey found that 83% of respondents—portfolio managers mostly at banks, insurance companies and asset managers—anticipate defaults increasing over the next 12 months, with 82% foreseeing increases in North America, 90% in Europe and 77% in Asia.
Central banks' aggressive interest-rate hikes to tame inflation have increased the likelihood of borrowers' interest-rate coverage falling short.
"Inflation is a problem in most markets and central bankers are determined to slow growth in order to contain rising prices," said Som-lok Leung, executive director of the IACPM.
The IACPM's 12 Months Corporate Credit Default Outlook Index had been wobbling in negative territory between -20 and -70, depending on the region, since at least September 2018. It plummeted across regions in early 2020 at the start of the pandemic when lockdowns were imposed, falling below -80 in Asia and -90 in North America and Europe. A reading of -100 would indicate all respondents anticipated higher defaults, while a score of 100 indicates defaults are expected by none.
As governments began pumping funds into economies and the outlook for defaults decreased, the index rose dramatically to modestly above zero across all regions by early 2021, indicating slightly more respondents expected defaults to decrease than increase. As government aid ended, however, the index descended over the next 18 months, reaching a low when the survey was conducted in early July 2022 of -90 in North America and Europe, and -80 in Asia.
"After the benign credit environment stemming from government actions, it was clear that at some point defaults would rise and credit deterioration would occur," Leung said.
After the survey in early October the index bumped up 10 percentage points in Asian and North America but remained flat in Europe, which has seen skyrocketing fuel prices and higher inflation.
The most recent index reading is somewhat less pessimistic than the previous quarter's, since "spreads have already blown out," but "it would be a mistake to say things look better now," Leung said.
The IACPA notes in a statement that one measure that could exacerbate the credit-default outlook is "TTM," or the trailing twelve months of a company's performance data. It adds that as TTM calculations add more high interest-rate quarterly time periods, more companies are likely to fall below a debt-service coverage ratio of one 1X, strongly signaling borrower weakness.
"As the universe of companies that fall below a 1.0 coverage ratio grows, we would expect to see a reflective level of higher defaults," Leung said.
Credit spreads are anticipated to continue widening, according to survey respondents, with the IACPA's Major Market Credit Spread Outlook Index most recently registering at -58, a modest improvement from -70 the previous quarter. The spread index has followed a similar if somewhat less volatile path compared to the credit default index, with Europe, again, seeing the worst results. Seventy-seven percent of survey respondents expect investment-grade spreads to widen in Europe, compared to 53% for North America, and 80% anticipate European high-yield spreads will widen compared to 13% in the North America.
