There are very few widely available data points for most investors to track corporate credit spreads. The corporate credit spread is the difference between the interest rate that a company has to pay and the US Government has to pay on their treasury bonds to borrow money. A company that issues debt at a spread of 250 bps over the 10 year treasury will have to pay 2.5% plus the current yield on the 10 year treasury. The credit spread represents the perceived riskiness of the company, its probability of default and ability to pay its debts.
In 2008, the credit risk of corporations blew out to record levels. If we just look at A rated and BBB rated US corporations, the tail event of 2008 stands out starkly:
- Credit spreads have widened, but not past expected levels of fear
The markets of 2008 showed us what happens when the financial markets freeze up. Loans and bonds are the lifeblood of the economy and when no one is willing to lend or will only lend at extremely high levels of interest rates then we question the solvency of such companies as General Electric. To date in 2011, the credit markets have not frozen. In fact, with the 10 year treasury at 1.75%, even with a 250 bps spread, companies are able to borrow money at very attractive levels of interest. Even at a spread of 300 bps a company will pay less than 5% pretax on that debt. Why can they borrow at such low rates? Because corporate balance sheets are in terrific shape.
What really stands out is the CMBS market. CMBS (Commercial Mortgage Backed Securities) represents pooled commercial loan assets. In 2008, this market absolutely imploded. Instead of gapping out from 60 bps to 600 bps, this market gapped out to nearly 1600 bps or 16% over treasuries. If we look at the current risk flare we see a 350 spread that actually seems stable at this level:
CMBS spreads lack their past flare
What is different about this market? Mostly it has just absorbed the losses. Commercial real estate has already fallen in price and appear to have bottomed out and might be at fair value. Therefore the loss expectations today are nowhere near what they were in 2007/2008:
Commercial Property Prices bottomed and recovering?
This same argument applies to the residential real estate market and the impact on bank balance sheets.
Are things rosy? No. Are things as bad as 2008? Not right now. If we do enter into a recession it seems improbable that we could see the depths of this last crisis.
