'This is not 2007': Citi analysts have poured cold water on the threat posed by excessive corporate leverage

A plane drops fire retardant behind homes along McVicker Canyon Park Road in California. (Mark Rightmire via Getty Images)
  • Corporate credit risk has increasingly come on the radar of major players in global economics and finance.
  • But analysis from Citi suggests conditions in the US commercial lending market aren’t conducive to a near-term market collapse.
  • Citi said current lending activity stands in stark contrast to the sudden withdrawal of credit prior to the 2008 financial crisis.

Anyone following markets in recent months would’ve probably heard about the risks posed by the buildup of debt in corporate bond markets.

The unprecedented rise in riskier “leveraged loan” issuance is on the radar of central banks, leading analysts and the IMF.

The main concern is that it leaves the global economy more vulnerable to negative shocks in an environment of rising interest rates.

But research from Citi’s US equity strategists presents a slightly more optimistic view on the risk outlook.

“We have heard some worry that leveraged loans, tighter Fed policy and widening credit spreads all present clear and present dangers” they said.

However, some of that worry has been overblown — an argument the analysts put forward via some historical context: “This is not 2007”. (A reference to the marked changes in lending conditions prior to the 2008 financial crisis).

For evidence, they pointed to the US Fed’s quarterly release of the Senior Loan Officers survey.

The survey provides a gauge on the market conditions for commercial & industrial (C&I) loans issued by US banks.

Citi said growth in US commercial lending is an important leading indicator for industrial activity and capacity utilisation — two key bellwethers for economic growth.

And in what the analysts called a “crucial piece of good news”, the latest survey suggests lenders aren’t withdrawing from the market just yet.

As shown in the charts below, that stands in stark contrast to 2007, when commercial lending collapsed prior to the global financial crisis:

Source: Citi

In turn, changes in industrial production and capacity utilisation have historically been good indicators of earnings growth for US stocks.

So the fact that both metrics are holding up suggests an imminent collapse in US stocks is unlikely.

However, Citi noted that 2019 earnings growth forecasts for US stocks remain high at around 9%.

That’s down from projections of 12% before the October selloff. But Citi said earnings projections will have to fall to around 6% before “markets can rally forcefully”.

For now, the current conditions in the commercial debt markets look unlikely to spark a near-term round of chaos on global markets.

“The current credit backdrop is conducive to US economic growth, not stagnation,” Citi concluded.

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