Of Special Interest


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15th March 2019

Next downturn unlikely to be as bad as 2008, according to S&P

The stage is set for another global credit downturn, but the next crisis, if any, is unlikely to be as dramatic as in 2008-2009. While global debt levels are higher than a decade ago, contagion risk is lower. That's according to a special report published by S&P Global Ratings, titled: "Next Debt Crisis: Will Liquidity Hold?"

The report discusses the latest trends in the credit cycle and opines on whether we are heading for another full-blown crisis. To come to its conclusions, S&P compared the debt-related metrics of corporates, governments, and households with those recorded during the 2008-2009 global financial crisis. This special report is part of the "When The Credit Cycle Turns" research series, which started in 2018.

Total global debt has surged by about 50 per cent since the last global financial crisis, led by major-economy governments and Chinese non-financial corporates, while global debt-to-GDP ratios have risen to more than 231 per cent, compared with 208 per cent in June 2008.

Despite higher leverage, the risk of contagion is mitigated by high investor confidence in major Western governments' hard currency debt. The high ratio of domestic funding for Chinese corporate debt also reduces contagion risk, because S&P believes the Chinese government has the means and the motive to prevent widespread defaults.

In looking at nearly 12,000 corporates globally, S&P found the proportion of companies having aggressive or highly leveraged financial risk profiles has risen slightly, to 61 per cent. The higher risk is partly driven by Chinese corporates, which now make up about two-fifths of debt S&P categorises as aggressive and highly leveraged.

While S&P believes contagion risk is lower than in 2008-2009, risks are elevated. Due to extremely low interest rates, the past decade has seen a migration of investor flows into speculative-grade and non-traditional fixed-income products. These markets tend to be less liquid and more volatile, and could seize in the event of a financial shock or panic.

Even within the investment-grade arena, there is also now a much higher issuer concentration in the 'BBB' rating category, with issuer ratings trending down globally over the past decade.

Other risk areas include derivatives, exchange-traded funds, private debt, leveraged finance and certain types of infrastructure. About 80 per cent of leveraged loans outstanding are now "covenant-lite" – indicating protection for investors has decreased – and this is up from 15 per cent a decade ago.

While default risks have been low in recent years, this could change as money costs increase and global economic growth tapers. S&P economists recently revised their assessment of the risk of a US recession in the next 12 months to 20 per cent-25 per cent, from 15 per cent-20 per cent late last year.

S&P Global Ratings analyst Alexandra Dimitrijevic said: "A perfect storm of realised risks across geographies and asset classes could trigger a systemically damaging downturn. This downside scenario reflects an increased reliance on global capital flows and functioning secondary market liquidity."