WASHINGTON (MNI) – In a roundtable discussion, their responses
where published Thursday in a CreditWeek report, senior analysts at
rating agency Standard & Poor’s observed that though the recession may
officially have ended sometime in the summer of 2009, most sectors
continue to feel its ripple effects. It seems that potential problems
that could derail a so-far tepid recovery are becoming more apparent.
The participants in the discussion included: Standard & Poor’s
Executive Managing Directors Paul Coughlin of Corporate & Government
Ratings and David Jacob of Structured Finance Ratings, and Managing
Directors David Beers of Sovereign Ratings, Jayan Dhru of Financial
Institutions Ratings, and William Montrone of U.S. Public Finance
The following are excerpts of responses to questions asked:
Given the economic environment, what is the credit outlook through
the end of the year and into first-quarter 2011 for corporate issuers?
Paul Coughlin: The expectation is that the defaults in the
corporate area will come off the highs that were registered in 2009 and
that we’ll continue to see a significant fall in the corporate default
rate. It will probably end up in 2010 to be half the level that it was
I think the challenge is going to be the enormous volume of debt
originated in 2005, 2006, and 2007 that will mature over the next
several years, particularly given the highly leveraged LBOs [leveraged
buyouts] that we saw in that period. And there is some question about
whether the sheer volume of debt that’s required will be available,
particularly in the context of the periodic lapses in confidence that
we’ve seen hit the market over the past year or two and potentially
could be out there in the future.
During 2005, 2006, and 2007, almost 60% of LBO finance came from
the CLOs [collateralized loan obligations], and we wonder how much of
that money is going to be there in the future. Clearly it will be less
than there was in that last cycle. CLOs still exist. A lot of them have
quite long lives. They’ll be looking to reinvest over the next few
years. But we wouldn’t expect much new money going into that area.
So the question is whether there will be enough volume out there to
roll over speculative-grade debt, especially low speculative-grade debt
at the ‘B’ level, in the absence of new money coming in from the CLO
sector. And will we continue to have these periodic lapses in confidence
in the marketplace?
I think the big issues for the next several years are whether we
will see default rates go back to something closer to normal (about 4.5%
on average for the speculative-grade portfolio) and whether the simple
volumes of debt available to refinance these deals will be sufficient.
We’ll probably expect 4% or 5% defaults this year. We would expect to
perhaps go under that next year. As we go out to 2011, 2012, 2013, and
2014, if the economy remains in this modest growth path then we should
see the default rates fall off quite significantly below that average
4.5% mark, closer to 2%, 3%.
But the key is whether or not cash will be available to finance the
rollovers. Certainly in the first four or five months of this year the
markets were very much open. It was clearly possible to refinance debt
at that time in the ‘B’ category. But will the markets be open in the
next several years, and will they be able to actually supply even larger
amounts of cash than they have done in the first half of this year?
What’s the credit outlook for financial institutions?
Jayan Dhru: The theme in banking continues to be one of transition.
The regulatory changes that are underway would most likely lead to the
biggest change in banking since the Great Depression–the future of
securitization, how banks capitalize themselves, how much risk they
take. That’s a longer term transition that the banks are working
Fundamentally though, there is improvement in the U.S. banking
system. But as our economists say, it’s not panic anymore; it’s just
fear. So the improvement is relative. In March, more than half of our
ratings had a negative outlook. On the banking side now, half of them
have negative outlooks. So the improvement is from a bad level. And
there’s a real difference between the rated universe and the unrated
universe. We believe that there will be more bank failures in the FDIC
[Federal Deposit Insurance Corp.] universe because of commercial real
estate issues. They just happen not to be rated entities. So failures
will continue. Between 2008 and 2010 (year-to-date), 251 banks with
combined assets of $613 billion have failed. Between 1990 and 1992, 418
banks with combined assets of $127 billion failed.
We have been doing stress testing for many European banks and
reflecting it in our ratings for over a year now. Globally, we’ve been
doing stress testing to assist our forward-looking analysis and to make
sure that we’ve taken into account reasonable levels of losses and to
see that banks are capitalized to address that. Fundamentally, banks are
improving capital positions. They are putting aside monies for reserves.
And the banks in Asia and Latin America are generally staying out of
trouble. There is commercial real estate-related risk in the Asian
banking system, but they are well capitalized and we generally believe
that they will not feel undue pressure during the cycle. The same is
true of Latin America.
On the insurance side, last year we went through stress testing for
investment portfolios of life insurance companies. They are also better
capitalized than they used to be. They raised capital in the equity
And what has happened is that not only the level of capital but
also the quality of capital has improved in both the banking and
insurance space. Property/casualty insurers have stayed out of trouble
during this time because they’re less asset-sensitive.
What is the credit outlook to the end of the year and into the
first quarter of 2011 for U.S. public finance?
William Montrone: While we see signs in some states of a nascent
economic recovery and a flattening of the revenue decline of the past
two fiscal years, we believe that the effect of the economic downturn on
state and local revenues will be felt beyond fiscal 2011. The end of
federal support from the American Recovery and Reinvestment Act will
pressure budgets and liquidity still further. Accordingly, we think the
current above-average level of downgrade activity will continue through
the next 12 months. Local government criteria-related upgrades will
continue to 2010 Midyear Outlook: Global Credit Markets May Be At An
Inflection Point decline as the year progresses.
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