MANAGING RISK AS THE CREDIT CYCLE TURNS
The four phases of the credit cycle are expansion, downturn, repair and recovery. Revenue and income, market liquidity, leverage, tightening or loosening underwriting standards, spreads and asset values all are related to the underlying economic conditions and the fiscal and monetary policies in place. At least this has always been the common wisdom.
But has the response by central banks to the Great Recession and the coronavirus (COVID-19) pandemic changed the credit cycle? Do their actions risk ‘supersizing’ it?
Central banks have introduced an immense amount of liquidity while leveraging their balance sheets. Government policies created payment holidays and foreclosure holidays while interest rates were driven to record low levels. This resulted in easy credit and record bond issuance for both investment and non-investment grade credits. Indeed, according to SIFMA, the total amount of US corporate bonds outstanding reached $10 trillion in the first quarter of 2022 – almost doubling over a 10-year period. At the same time, issuance of high yield debt in 2021 reached $485bn – a new all-time high. In comparison, the average issuance of high yield in the decade preceding the great financial crisis was less than $100bn per year.
In addition, these factors also created record debt-to-GDP ratios on a global basis, with several developed countries surpassing the 100 percent mark for the first time in their history.
How will sovereigns, leveraged companies and households generate adequate debt service coverage considering rising rates and economic slowdowns? Did well-meaning government policies create an environment where zombie companies produce deflationary pressures as they cut prices to generate cash, forcing stronger companies to match them?
Oct-Dec 2022 Issue
SAS Institute