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Alternative Investment

Credit Market Cracks Widen As Distressed Debt Nears $650 Billion

Multiple stress points are emerging in credit markets after years of excess, from banks stuck with piles of buyout debt, a pension blow-up in the UK and real-estate troubles in China and South Korea.

With cheap money becoming a thing of the past, those may just be the start. Distressed debt in the US alone jumped more than 300% in 12 months, high-yield issuance is much more challenging in Europe and leverage ratios have reached a record by some measures.

The strains are largely linked to aggressive rate increases by the Federal Reserve and central banks around the world, which have dramatically changed the landscape for lending, upended credit markets and pushed economies toward recessions, a scenario that markets have yet to price in.

Globally, almost $650 billion of bonds and loans are in distressed territory, according to data compiled by Bloomberg. It’s all adding up to the biggest test of the robustness of corporate credit since the financial crisis and may be the spark for a wave of defaults.

“Many are likely to be slightly more complacent than they should be,” said Will Nicoll, chief investment officer of Private & Alternative Assets at M&G. “It is very difficult to see how the default cycle will not run its course, given the level of interest rates.”

Banks say their wider credit models are proving robust so far, but they’ve begun setting aside more money for missed payments, data compiled by Bloomberg show.

Loan-loss provisions at systematically important banks surged 75% in the third quarter compared with a year earlier, a clear indication that they are bracing for payment issues and defaults.

Most economists forecast a moderate slump over the next year. A deep recession, however, could cause significant credit issues because the global financial system is “vastly over-leveraged,” according to Paul Singer’s Elliott Management Corp.

Right now, the outlook for economic growth is a concern. Rolling recessions are likely across the globe next year, with the US likely to slip into one in the middle of next year, Citigroup Inc. economists wrote in a note.

The first half of 2023 will be “bumpy” and “characterized by higher for longer volatility” Sue Trinh, co-head of global macro strategy at Manulife Investment, said on Bloomberg Television. “There is a little ways to go in terms of fully pricing in the global recession risk,” she said, adding that financial conditions are likely to improve in the second half of the year.

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