Market Overview

Are We In A Corporate Credit Bubble?

Are We In A Corporate Credit Bubble?

Is there a US corporate credit bubble?

Of course, there is no simple answer to such an elaborate question, but there are more bearish and bullish views on the state of the US corporate credit cycle. In a report issued Monday, UBS strategists Matthew Mish and Stephen Caprio went over these two perspectives, and shared their view on the issue.

Bulls argue that “corporate fundamentals  are deteriorating incrementally, and from a relatively healthy position… US corporate debt to profits, assets and net worth do not appear extreme [and] While US corporate profit margins are elevated, they will not decline materially in the intermediate term.” Meanwhile, bears assure “Credit fundamentals, particularly in US speculative grade, are in a more dire state.”

UBS’ view stands somewhere in between, but is skewed towards the more bearish stance. The experts contend that “There is a bubble in speculative grade credit,” and that structural downside risks for high yield bonds and loans are not at all negligible. In the last cycle, credit losses were somewhat capped by easy central bank policies, which helped keep many “zombie” firms running. In addition, the analysts explained, QE led to large inflows into credit funds, which in turn ignited “a material reach for yield.”

This situation resulted in higher competition, laxer credit standards, and massive issuance. And, as many investors were pegged to nominal returns, they were forced to buy double and single B corporates.

As per the report, UBS analysts believe approximately 40 percent of all issuers are of the lowermost quality, and about $1 trillion, “which will end up 'distressed debt' in this cycle. Much of the debt was bought to pick-up yield linearly, but the default risk is exponential. Simply put, clients were not being compensated for the credit risk,” the note concluded.

Disclosure: Javier Hasse holds no positions in any of the securities mentioned above.

Posted-In: Matthew Mish Stephen CaprioAnalyst Color News Treasuries Econ #s Analyst Ratings Trading Ideas Best of Benzinga


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