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Credit market ‘futures’ point to company debt default gloom – Article FT.com

Posted by Adrian on February 8, 2008

According to an article written in the Financial Times online, indebted company defaults are at an all time low. As I have mentioned, the credit crunch is in infancy as the direct effects have yet to be felt on a wider economic level.

Credit markets have ‘futures’ indicators, one being the iTraxx Crossover Index (which is used to measure possible default of companies that are at risk – as seen by credit rating agencies), high yield risk spreads and the VIX indicator, although not entirety an indicator that speculates defaults and risk amongst corporate bonds. The VIX is the volatility indicator from the options markets (‘calls’ and ‘puts’).

So with default rates low on indebted companies, the European iTraxx indices which is used to measure spikes in risk assumption is at an all time high, according to the FT.com,

“One of the most important indicators – the iTraxx Crossover Index for mainly high-yield companies in Europe – soared to a record closing high this week, well above levels at the height of the credit crisis in August.”

The other indicators are the high yield spreads between junk rated debt and government treasury rates, an alarming quote from the FT.com article,

“High-yield spreads, which measure the risk premium between junk-rated debt and safe government bonds, have also risen by about 100 basis points this year, while leveraged loans are trading well below par.

Some bankers say secondary market prices for leveraged loans are assuming corporate default levels last seen during the Great Depression of the 1930s.

The picture is mirrored in the high-yield bond market. As Martin Fridson, chief executive of research service Fridson Vision, says: “Never before have we seen high yield spreads around 600 or 700 basis points over Treasuries with default rates so low.

“When spreads reached their current levels during the last two cycles, the economy entered a recession exactly eight months later. With rates so low, it means we’re anticipating a lot more pain than we already have.”

Mark Kiesel, portfolio manager at Pimco, says: “The credit market has definitely priced in the pain early this time,” although he stresses the high-yield market has not yet fully priced in a recession. “During the last recession, high-yield spreads reached 1,000 basis points.”

The Financial Times article concludes with theories on the current low default rates, these range from the massive amount of registered companies, the inability to properly measure a default rate and the refinancing of debt prior to the onslaught of the credit crunch mid 2007. With massive amounts of credit that was uses to expand in the company market, it has been suggested defaults could pause as a wave of *’zombie’ companies emerge.

It’s a very good article from the Financial Times online dealing with the credit markets next step in decline and the fact that most bankers, traders in someways have already factored in massive defaulting on company debt.

Generally there appears to be a lot of confusion, lies, apprehension and denial in accepting that the world 1. is going to slow to the point of recession, 2. the US is already in a recession and may enter even a severe recession.

The markets speak for themselves, so it would be advisable to keep an eye on the futures, stocks, FX markets; and be aware of the global fear factor, global recessionary conditions and global credit crunch.

*Zombie Companies (from investorpedia):

“Zombie
In the supernatural world, a zombie is a reanimated corpse infused with the magical energy of voodoo.

Zombies in the investing world aren’t that different from their supernatural cousins. They are companies that are insolvent or on the brink of insolvency, but are still operating as if nothing’s wrong. Although zombies are in or close to Chapter 11 – which allows a business to continue to operate while restructuring its debt – a zombie company is perceived as not having a chance. Therefore, much like the supernatural zombie, the corporate zombie doesn’t know that it’s already dead. As an investor, you should avoid zombie companies like you would avoid the living dead.”

Full article from FT.com Credit gloom drives up cost of debt risk

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