Corporate defaults could be about to rise, according to Deutsche Bank (DB)’s closely watched annual default study, launched this morning.
Analysts from Europe and the United States at the investment bank have done the maths and warned that the number of companies unable to pay their debts will tick up over the next few years.
“In spite of all the challenges we face, this era has been characterised by astonishingly low default rates,” DB said. “There are clear signs the cycle is turning though, especially in the US.”
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Three key indicators which have historically predicted a rise in the number of defaults - debt levels, tightening monetary policy combined with flatter yield curves, and the possibility of an external shock - are all flashing red, according to DB.
“The pieces of the jigsaw are building. US corporate debt accumulation now compares with that seen prior to previous default cycles. Equity volatility has seen two spikes in the last year, bank equity is falling, and global yield curves continue to flatten.”
The warning, while tempered by the fact that DB believes that “the next default cycle could still be contained,” comes off the back of Societe Generale analyst, Albert Edwards, warning that the US economy was about to be “swept away by a tidal wave of corporate default”.
The unprecedented era of monetary policy in Europe, where the European Central Bank (ECB) is currently buying not only government debt but also corporate bonds through its €80bn (£64bn) a month quantitative easing programme, will limit the rate of default to somewhere between five and seven per cent, DB reckons.
Globally, the default level increased from 0.9 per cent to 2.7 per cent in 2015 - though this was “still lower than all of the first two decades of the modern era of leveraged finance up to 2003”.
If the default rate in the US increases and this spills over into an American, or even a global recession, however, DB said that their outlook would change, warning that “the era of heavy financial repression and very active central banks” means that predicting how severe the looming default cycle will be is a tricky business.