2007

Liar, Liar, Pants on Fire?

When it comes to the credit crisis we know this statement is not true. However, the true extent of the crisis remains unfathomed and much of the data surrounding it may be misleading lulling us into a sense of security that is both unwarranted and dangerous. Two reports from Lars Kirkeby and Maths Liljedahl of Nordea Credit Research provide an interesting perspective on this much talked about subject.

Looking in particular at the Norwegian High Yield Market, Mr. Kirkeby sets the stage for his presentation showing the historical iTraxx 5-year crossover index representative of spreads on high yield corporate issues together with a graph showing the number and rate of speculative grade defaults. After a rapid rise from near historic low levels the spreads reached a high but then quickly fell back to earth or at least the recent historical range largely as a consequence of the Fed rate cut. Also, after a difficult period between 1999 and 2003, where default rates were in excess of 6%, these rates have subsequently fallen to below 2% over the last four years.

Interestingly, as a side note, this fine performance in terms of defaults has exacerbated the crisis in an unexpected manner. Fearful of banks managing their earnings, loss reserves have to be based on actual experience leaving the banks under-reserved in many instances. Taking on new reserves coupled with actual write-offs makes things twice as bad.

This is only an excerpt of Market Commentary – 10/25/2007

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