Credit Spreads to Flatten as Defaults Rise, IACPM Survey Says

Credit spreads will be unchanged over the next three months in the U.S. and Europe while global corporate defaults will rise “modestly” in the next year, according to the International Association of Credit Portfolio Managers.

The outlook for borrowing costs is “sharply different” from the view taken by lenders at the beginning of the year, when they forecast spreads would tighten during the first quarter, said IACPM, whose 86 member firms include banks, insurance companies and money managers in 17 countries. They now project margins on high-yield and investment-grade debt in the U.S. and Europe will be unchanged in the next three months, according to a member survey conducted by the New York-based organization this month.

The results show that credit markets may be headed for a shift that’s “just an event or two away from a reversal” of bullish investor sentiment, according to Som-lok Leung, executive director of the IACPM. While 43 percent of surveyed members expect corporate defaults will stay the same over the next year, their outlook became more negative since the previous survey, with 38 percent predicting they will rise, compared with 32 percent.

“A lot has happened in the last quarter, the biggest thing being Cyprus,” Leung said in a telephone interview. “I actually would have expected things to look a little bit worse.”

Cyprus, the fifth euro-zone country to tap international aid in Europe’s sovereign-debt crisis, is under pressure to reduce its financing needs as it seeks to stay solvent.

European Outlook

Investors predict European corporate defaults will stay about the same over the next 12 months even as their outlook for the region is still the most negative on a global basis, the IACPM survey shows.

The trailing 12-month global speculative-grade corporate default rate finished the first quarter at 2.4 percent, down from 2.8 percent at the end of last year, according to Moody’s Investors Service.

“The global default rate has been remarkably steady over the past year,” Moody’s said in an April 8 report. “With a combination of accommodative monetary policy and weak fundamental growth, we expect this to continue for the rest of the year.”

The ratings firm estimates the default rate will be 2.8 percent at the end of 2013.

The Federal Reserve has kept its main interest rate near zero since December 2008 to spur economic growth. The central bank’s Chairman Ben S. Bernanke is also pressing on with $85 billion in monthly bond buying to stimulate the economy until the labor-market outlook has “improved substantially,” according to the minutes of the Federal Open Market Committee’s meeting in March.

Economic Growth

Gross domestic product probably grew at a 3 percent annualized pace in the first quarter, according to the median of 76 economist estimates in a Bloomberg survey taken April 5 to April 9. The U.S. economy grew at a 0.4 percent annual rate in the fourth quarter due to the biggest slump in military spending since 1972 and a reduction in the rate of inventory building.

Speculative-grade, or high-yield, debt is rated below Baa3 by Moody’s and less than BBB-by Standard & Poor’s.

Bond Spreads

U.S. high-yield bonds had an average spread of 478 basis points more than comparable Treasuries on April 16, narrowing from a 623-basis-point margin a year ago, according to a Bank of America Merrill Lynch index.

Leveraged loans sold to non-bank lenders averaged 384 basis points more than lending benchmarks as of April 11, according to S&P Capital IQ Leveraged Commentary & Data. That compares with a spread of 498 basis points for the high-yield, high-risk debt in April 2012.

“The view is, things are flattening out,” said New York-based Leung. “There’s not a lot more room to narrow from current levels.”

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