Bangkok--24 Jan--Standard & Poor's
The U.S. corporate bond market closed out 2006 on a high note, and 2007 credit conditions continue to look calm, as seen in tighter spreads, lower equity market volatility, and falling interest rate volatility, according to a report published by Standard & Poor's today. The article, which is titled, "Outlook For U.S. Corporate Bonds: Calm And Cautious," says however, that undercurrents of tension are surfacing, with LBO rumors periodically roiling the credit space, although we remain alert to signs of leverage fatigue on part of investors.
"While credit quality stabilized in 2006, with fewer downgrades and more upgrades than in 2005," says Diane Vazza, head of Standard & Poor's Global Fixed Income Research Group, "we believe that systemic risks are building up. In particular, the prolonged macroeconomic slowdown should dent profits and raise the interest burden, which sets the stage for a riskier phase of the corporate credit cycle. We expect credit quality to deteriorate gradually, which should widen spreads during the second half of 2007."
Although overall sentiment surrounding the bond market looks strong, we see some signs of nervousness coming into play. A fairly robust December employment report, which showed 2006 wage inflation of 4.2% (versus 3.2% in 2005 and 2.5% in 2004), has raised concerns about profit margins and pulled back hopes of a near-term Fed easing. Investment-grade spreads are looking more volatile than before, so while ample liquidity continues to traverse through financial markets, we expect investors to become more parsimonious and risk averse as the year progresses.
Ms. Vazza added that "Issuance surged by 37% in 2006 to a record $981 billion, and we expect 2007 issuance to stay elevated with hectic LBO and M&A activity, along with capital expansion plans. Sluggish profits growth is likely to increase the LBO drive, and the mega-size deal pattern could persist."
For now, ample liquidity is delaying the default cycle, as high-yield issuers have been liberally tapping both the bond and leveraged loan markets. We caution that any rise in default incidence is likely to test investor confidence. With the percentage of high-yield issuers on negative CreditWatch or outlook outpacing those on positive CreditWatch.
The report is available to subscribers of RatingsDirect, the real-time Web-based source for Standard & Poor's credit ratings, research, and risk analysis, at www.ratingsdirect.com . If you are not a RatingsDirect subscriber, you may purchase a copy of the report by calling (1) 212-438-9823 or sending an e-mail to [email protected] . The report is also available at www.sandp.com/gfir , listed under Global Fixed Income Research. If you have not previously registered with the site, you will need to do so to access this material. Registration requires minimal information and is free. Members of the media may request a copy of this report by contacting the media representative name provided.
Media Contact:
Mimi Barker, New York (1) 212-438-5054, [email protected]
Analyst Contacts:
Diane Vazza, New York (1) 212-438-2760