Morgan Stanley: "Credit Faces Real Risk In The Next Downturn"

Morgan Stanley: "Credit Faces Real Risk In The Next Downturn"
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By Morgan Stanley's chief cross-asset strategist, Andrew Sheets

Anniversaries provide an opportunity to reflect on how things were in the past and how they will be in the future. The passage of 10 years since the bankruptcy of Lehman Brothers is no exception. But given the volume of retrospectives on Lehman itself and the causes and implications of its collapse, we are taking a slightly different approach. Lehman was a reminder that conditions can change quickly and that cycles ebb and flow. What will be different when the next downturn hits?

The first difference ties to an old saying in credit markets: the same sector usually isn't the problem twice. High bank and consumer leverage defined the run-up to the last downturn, but both segments look very different today. Debt/income levels in US households currently sit near 40-year lows versus 40-year highs in 2006, in part because mortgage lending standards remain materially tighter than pre-crisis. The core Tier 1 ratio for US and European banks has more than doubled over the same period.

US corporates, in contrast, have followed a different path. Taking advantage of low rates and strong demand in the QE era, companies have issued records amount of debt. Debt/EBITDA for US issuers and corporate debt/GDP for the US economy as a whole are both near 30-year highs.

Average credit quality has declined as a ....

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