Conference Presentation, Panel
MI Summit 2013 - London: Credit Markets at a Crossroads
Milken InstituteRichard Byrne, Tom Corcoran, Robert Kricheff, Brian Pinto, Robert Ruberton, Komal Sri-Kumar, Bob, Rob, Rich
- The total US credit-to-GDP ratio has risen to 3.5x since 2012, while fixed income inflows have pushed off maturities, potentially masking underlying credit issues.
- High-yield spread dispersion has compressed to its lowest level in five years, and correlations with Treasuries have reached historic highs, resulting in crowded trades where the Sharpe ratio is rendered less meaningful.
- There is a risk of reduced vigilance regarding credit quality, which could lead to future market problems if conditions reverse; such a reversal is anticipated to be a liquidity and transfer risk event rather than a pure credit event, causing spreads to widen significantly between single-A and distressed assets.
- Dealer inventories have fallen 75%, creating a structural imbalance where the buy side is significantly larger than a capital-constrained sell side.
- Apollo is raising large private equity and global credit funds and views European bank deleveraging as a decade-long trend offering opportunities, particularly in direct lending for troubled geographies like Italy and Portugal where they can justify higher capital costs.
- Apollo dismisses the direct lending pitch in Europe for performing SMEs as overhyped, as their cost of capital cannot compete with German or UK banks, and compares the expected European deleveraging duration to the 10- to 15-year process seen in Japan.
- Corporate fundamentals are viewed as strong with expected outperformance against equities in a 2% to 2.5% GDP environment, whereas higher growth scenarios typically see equities take the lead.
- Skepticism exists regarding US GDP reaching 3% next quarter, noting a four-year streak of missing that target, and while the equity market has rallied on growth promises, forward earnings models may be slightly off.
- Developed market fundamentals are improving, likely increasing differentiation among emerging markets, with the BRIC story potentially diluted by pretenders like Mexico or sub-Saharan African nations.
- Emerging markets are considered more credible than in 1997 with a very low probability of another major crisis, though chasing alpha in crowded fixed income markets is discouraged in favor of capital preservation and steady income.
- Bank capital costs are expected to rise significantly due to Basel III and CRD4 requirements, leading banks to shrink capital markets divisions despite becoming better credits.
- The normalization of US monetary policy is expected to be a multi-year volatile process involving a gradual Fed unwind driven by deficit and trade pressures to avoid spooking capital markets.
- US government shutdowns and debt ceiling issues are viewed as noise, though the potential for a technical default is acknowledged without expecting a failure to honor debt obligations due to the dollar's exorbitant privilege.
- A $230 billion wall of maturities for European corporations is expected over the next two years, forcing access to the high-yield marketplace as bank lending to non-financial corporates declines.
- European corporations will face higher borrowing rates compared to better times, and the CLO spigot is expected to end, though returns can be excess if constructed with proper spreads and equity cushions.
- A potential future crisis could be triggered by a highly leveraged firm with a "macho" name starting with "L," referencing historical entities like Lehman or LTCM.