By Chiara Elisei
LONDON (Reuters) - Corporate credit quality is weaker than financial markets currently price in, while defaults are likely to pick up in the second half of the year, a report by Janus Henderson Investors said on Friday.
Indicators such as debt loads, access to capital markets, cash flow and earnings continued to flash red in the second quarter, the fourth three-month period in a row, the asset manager said in its latest global credit risk monitor.
Key measures it tracks showed a broad - although shallower -deterioration in the second quarter.
Tighter lending standards, higher refinancing costs and a slowing economy would take their toll on the credit quality of corporates, the report said.
This suggests that defaults could pick up in the second half, even if the pace of defaults is slower than in previous cycles, it added.
Tighter financial conditions compounded by weak manufacturing PMIs contributed to earnings downgrades for some firms in the industrials sector.
Additionally, a recent trend of small businesses being forced to file for bankruptcy is likely to spread more broadly into capital markets, Janus Henderson noted.
S&P Global (NYSE:SPGI) expects default rates for U.S. and European sub-investment grade companies to rise to 4.25% and 3.6% respectively by March 2024, from 2.5% and 2.8% this March.
Debt-laden firms such as French retailer Casino have been downgraded to junk due and forced to start negotiations with creditors to restructure their liabilities.
The cost of insuring exposure to a basket of European junk-rated corporates in mid-July briefly hit its lowest in just over a year, a sign that investors remained largely unperturbed by rising default risks.
"As recession fears scaled back, markets have been pricing in a more muted credit default cycle. Our view is more circumspect, as we expect more 'trouble credits' to emerge as the lagged impact of tighter policy takes effect," said Jim Cielinski, global head of fixed income at the firm, which has around $311 billion in assets under management.
"That said, the timeline could be protracted, given many companies will not refinance for the next one to four years, on average," he added.