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Capital Markets

Late Stage of Credit Cycle While Slower China No Threat

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June 26, 2018

Fitch: Despite threats, US corporates can withstand economic downturns.

The US high-yield market is in the latter stages of its credit cycle, while China—a major market for US multinational corporations—has already started to see its economic activity slow. Both factors, however, may have a less impact on US corporates than might otherwise be anticipated.

Fitch Ratings notes in a June 4 report titled "U.S. High Yield Default Spike Characteristics" that the rating agency believes the domestic high-yield market is in the latter stages of the credit cycle, which typically precedes an economic downturn. Similar to the lead-ups to the 2001-2002 and 2008-2009 recessions, the economy and leveraged finance markets today are strong, and defaults are low.

Defaults in the energy and mining sectors reached 19.7% in 2015 through 2016, and the retail sector is currently experiencing hiccups. However, Fitch anticipates the overall default rate this year will remain at a low 2%, a level in line with the 2.3% non-recessionary average. The rating agency notes that while there were similar trends preceding the earlier recessions, there are "notable differences that support default rates remaining low through 2019 despite being in the late stages of the cycle."

For one, the Federal Reserve loan officer survey continues to show easing standards for large and middle-market firms, whereas credit was starting to tighten in the later stages of the previous two credit cycles. In addition, the US high-yield distressed yield ratio stands today at just over 4% and has remained below 10% since fourth-quarter 2016. That compares to a ratio of more than 10% in 1999 and 37% in 2000, and 10% in late 2007, peaking at 83% in November 2008.

Another positive indicator is that CCC-rated debt now makes up only 13% of the high-yield market, down from 18% at the end of 2015. In 2006, CCC-rated debt made up 19% of the high-yield market and that rose to 22% a year later, reaching 36% by the end of 2008. Fitch's indicators suggest highly leveraged US corporates are much stronger in the later stages of the credit cycle today than they were the last two times, and moving forward companies' non-investment grade suppliers and customers are likely to create fewer headaches.

Another potential weight on US technology and industrial firms is the Chinese economy's slowdown. Fitch forecasts China's real GDP slowing to 6.5% this year, 6.1% in 2019 and 5.5% in 2020. A further decline, say to between 4.5% and 5%, could meaningfully pressure global commodity prices, Fitch says in a report titled, "Fitch: China Slowdown Poses Modest Risk to US Technology, Industrials," also published June 4. However, it would not "profoundly" affect the US economy or sales within the US technology and industrial sectors over the near to intermediate term.

Fitch cites long-term trends such as digital transformation of mechanical/analog content, explosive data growth and the continuing migration to cloud-based services as factors offsetting any slowdown in Chinese technology demand. Similarly, the impact of a slowdown might also be muted in industrials. For example, Boeing, the largest US exporter, generates more than 12% of its consolidated revenue from China. Slower growth is causing a reduction in air traffic expansion but would be offset by other positive factors supporting the sector, such as lower oil prices.

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