Almost 75% of credit portfolio managers expect global corporate defaults will increase from very low levels in the next 12 months, according to a survey released on Thursday.
Not a single respondent to the International Association of Credit Portfolio Managers survey anticipates default rates will drop. It's the worst quarterly outlook since mid-2009, during the depths of the Great Recession.
"We're finally starting to see a consensus. Most people think the turn of the cycle will be happening in the next year," said Som-lok Leung, executive director at IACPM. "We've been in a benign credit environment for a very long time. It won't stay like that forever."
None of this means defaults will spike to the levels experienced in the aftermath of the 2008 financial crisis. Rather, investors are acknowledging that the historically low level of defaults will inevitably climb as economic growth slows.
"Things can't get much better. They can only get worse," Leung said.
In 2018, global corporate defaults fell to a four-year low of 82, according to S&P Global Ratings. US defaults were also at the lowest since 2014.
Credit ratings firms are calling for a modest but noticeable uptick in defaults this year. "We believe we are incrementally closer to a turn in the credit cycle in 2019," S&P Global Ratings wrote in a report on Wednesday.
Record-high corporate debt
Several high-profile companies have already succumbed to financial stress lately. Toys 'R' Us filed for bankruptcy in September 2017 as poor sales exposed hefty debt piled on by private-equity firms.
Children's clothing retailer Gymboree announced this week that it's making another trip to bankruptcy court -- its second in less than two years. PG&E (PCG), the California power company facing billions of dollars in claims over the deadly 2018 Camp Fire, announced this week that it will soon file for bankruptcy as well.
The bankruptcies serve as a fresh reminder of the elephant in the room during the recent market stress: US companies have binged on a ton of debt to expand, fund acquisitions and pay for massive share buybacks.
While the last crisis was caused by massive household debt and overleverage on Wall Street, corporate debt is the central area of excess today. That makes it an obvious trouble spot for whenever the next recession strikes.
The ratio of nonfinancial corporate debt to GDP has never been higher, according to records from the Treasury Department's Office of Financial Research that began in 1947.
Dimon: We won't be 'stupid'
JPMorgan Chase CEO Jamie Dimon said on Tuesday that "credit it pristine" right now and underwriting standards are "pretty good." However, JPMorgan also significantly raised its provision for credit losses and Dimon said he's fine with shrinking the loan book if needed.
"We are not going to be stupid," Dimon said. "We stay in a business knowing there's going to be a cycle and we're not going to be children in this cycle. We know the losses are going to go up."
Yet the end of the credit cycle may not be imminent. Record-high profits give businesses plenty of ammo to pay down debt. And companies have taken advantage of a decade of extremely low interest rates to refinance debt.
"Most" companies have "low" refinancing risk in 2019, according to Fitch Ratings.
'End-of-cycle' behavior
Still, some warning signs have emerged.
Fitch's tally of "top bonds of concern" climbed in January to $15.5 billion from $13.8 billion the prior month. This troubled list includes debt-laden department store Neiman Marcus, supermarket chain Fresh Market and multiple oil drillers.
Meanwhile, the US junk bond market has slowed to a near-halt, underscoring how quickly companies get blocked from borrowing when markets seize.
Lured by low default rates and easy money, investors have for years piled into the riskiest corners of the debt market. Leveraged loans -- ones made to distressed companies have boomed. And many of these are covenant-lite loans, a type of financing with limited safeguards for investors.
"When default rates are low, investors are more willing to take less protection," said Ryan Vogel, senior fixed income portfolio manager at Wilmington Trust. "That tends to be an end-of-cycle type behavior."
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