Fixed Income  

S&P warns of credit market ‘Crexit’

S&P warns of credit market ‘Crexit’

Over-leveraged companies and political shocks could bring about a correction in credit markets in the coming years, S&P Global Ratings has warned.

In a paper studying global corporate debt demand, authors Terry Chan, Diego Ocampo, David Tesher and Paul Watters said a correction in the credit cycle began in late 2015 - though this has since continued only as a “slow burn” phenomenon.

This “orderly” correction remains the trio’s base case, but they also sought to flag a number of headwinds for the market after several years of strong growth.

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Between 43 and 47 per cent of non-financial corporate borrowers have too much leverage, according to the analysts, who suggested some 5 per cent would ultimately default and fail to survive a “meaningful stress scenario”.

The analysts said: “The credit-fuelled growth has also subjected investors to an increasingly asymmetric risk/reward environment.

“Investors are buying speculative-grade corporate debt, including those from emerging markets, and extending maturities to generate positive yields. As a result, the reward is becoming increasingly unsustainable given the level of risk taken, signalling an inevitable recalibration to a more normalised risk/reward environment.

“With weakened borrower credit quality, a credit correction is inevitable.”

The paper suggested corporate debt demand will hit $62trn (£47trn) over the next four years.

However, the analysts added that despite this expansion, a correction would occur given the high leverage levels seen among global companies, and the fact that credit demand could not continue to grow faster than income forever.

It added: “There are scenarios that could spark a credit crunch…a series of negative economic and political shocks that trigger a re-pricing of risk, resulting in escalated distressed debt and defaults as lenders seek to exit or hedge the riskier portions of their portfolios (a ‘Crexit crisis).”

The analysts’ ‘base case’ of $62trn of global credit demand over the next four years is $5trn higher than projections made in 2015. S&P Global Ratings said 40 per cent of this issuance would be new, with the remainder refinancing.