of the US subprime mortgage crisis, financial markets have enjoyed
a period of comparative calm since mid-March. However, it is too
early to declare the financial crisis over as rising defaults in
other sectors threaten to bring with them further significant
Just as a modicum of stability appears to have returned to
global financial markets hit by the US sub-prime mortgage crisis
Christine Li, an economist at rating agency Moody’s Investor
Services, poses the question: Is the financial crisis really over?
Her analysis and that of others suggests that more losses are still
A ray of hope that the worse may be over has been provided in the
recovery since mid-March of the speculative grade debt markets.
This recovery has seen the spread between speculative grade and
investment grade bond yields narrow from about 760 basis points to
just above 600 basis points in late-May, though this is still well
above about 200 basis points in the first half of 2007.
The recovery, believes Li, represents no more than a “mini-rally”
that may not last because an expected broader based rise in
defaults could cause credit spreads to widen again. Notably, other
industries are also likely to join the sub-prime mortgages as a
source of financial strain. “The worst of the crisis might be over
[in the sub-prime market], but the pain to the real economy and the
corporate sector could still lie ahead,” cautioned Li.
Li explained that in Europe for example, corporate speculative
grade bond default rates are currently low at 1.46 percent because
borrowers took advantage of the high liquidity before the credit
crunch and refinanced, lowering their borrowing costs and extending
debt maturities. However, deteriorating economic conditions in
Europe are expected to take their toll – especially in industries
such as consumer durable goods, hotels and leisure and, forecasts
Moody’s, European speculative grade default rates will rise to 4.53
percent in the next 12 months.
Moody’s’ caution is shared by rating agency Standard & Poor’s
(S&P). In research published in early-June S&P analyst
Taron Wade warned that European speculative-grade companies’ cash
coverage to make interest payments was lower in the first quarter
of 2008 than in 2007 “when they were already at record thin
Wade continued: “Thin credit metrics mean that companies have less
of a cash cushion if market conditions change or additional capital
needs to be invested in the business, resulting in a greater risk
She cautioned that at a time when economic difficulties are
beginning in Europe, in a debt market where defaults are likely to
rise from record lows lenders must be vigilant.
Similar warnings of further problems in the US have come from the
International Monetary Fund (IMF).
“The credit shock emanating from the US subprime crisis is set to
broaden amid a significant economic slowdown,” said the director of
the IMF’s Monetary and Capital Markets Department, Jaime Caruana,
at a recent press conference. “The deterioration in credit has
moved up and across the credit spectrum to prime residential and
commercial mortgage markets and to corporate credit markets.
Default rates are likely to rise across the board,” he
US default rates are already rising at an alarming pace in sectors
other than housing. According to the American Bankers Association,
for example, in the private vehicle finance market payment
delinquency rates (payments 30 days or more overdue) were 7.1
percent in February, the highest level in ten years.
There are also signs of strain in the US credit card market where
according to credit management specialist, TransUnion credit card
loan delinquency rates based on the percentage of card users 90 or
more days in arrears ended 2007 at 1.36 percent, up 32 percent
compared with the third quarter of 2007. TransUnion forecasts a
delinquency rate of 1.9 percent by the end of 2008.
Among observers that believe a US credit card debt crisis is
looming is non-profit research organisation the Center for Economic
Recently, the Center warned: “Increased defaults could unravel the
$915 billion in securitised debt backed by credit card receivables,
just as delinquencies in the housing market unraveled the $900
billion in mortgaged-backed securities.”
Even optimism that the worst of the US home mortgage related crisis
is over may be premature. According to TransUnion, loan delinquency
(the percentage of borrowers 60 or more days in arrears) in the $8
trillion mortgage market ended 2007 at 2.99 percent and is forecast
to reach 4 percent “or greater” by the end of 2008.
As banks, insurers and others in the financial services industry
count already massive losses incurred on their mortgage-backed
investments the potential of further losses on other debt
securities is unnerving.
Indicative of losses to date, rating agency Fitch estimates that as
of May 2008 sub-prime mortgage related losses incurred by banks
totalled between $200 billion and $275 billion.
This estimate, said Fitch, represents about half of all losses, the
balance being incurred by insurance companies, asset managers,
financial guarantors and hedge funds.
An estimate of how high total sub-prime mortgage debt losses could
still climb has been made by the IMF.
In its 2008 Global Financial Stability report published in April
the IMF noted that falling US housing prices and rising
delinquencies on mortgage payments could lead to total losses
related to the residential mortgage market and related securities
of about $565 billion, including an expected deterioration of prime
The IMF continued that adding other categories of loans originated
and securities issued in the US related to commercial real estate,
the consumer credit market, and corporations increases aggregate
potential losses to about $945 billion.
Indeed, as Li cautions, the financial crisis may yet be far from