With markets obsessively following the oil price and sentiment out of China, other important data is easily overlooked; in the last few days we have had enough news to shed reasonable insight into credit conditions and credit quality both here and in the US. 
First of all, on Thursday and Friday we had results from three big banks in the US - JP Morgan, Citigroup and Wells Fargo. All were marginally ahead of expectations but have seen their share prices drop 15 per cent, 22 per cent and 12 per cent respectively over the last month.
Naturally these banking powerhouses will have exposure to the troublesome sectors of metals, mining and energy, but this is actively provisioned for, both specifically and through a substantial general provision that covers all lending.
They are also the banks that should benefit most from the Fed’s first hike. In the case of JP Morgan, they also had their capital hurdle lowered. None of this is seemingly relevant while the market is focussed on potential contagion from the energy rout though.
However, there are very few lenders with as much insight into the state of US credit quality, so when JP Morgan’s CEO specifically comments on it, we think it is worth taking note. “Credit quality across card (unsecured lending) and commercial lending business is as good as it’s ever been” … “the US economy looks pretty good at this point,” said Jamie Dimon.
Here in the UK on Friday we had the latest release of the Bank of England’s quarterly Credit Conditions Review.
This report provides an excellent insight into the state of UK banks’ liabilities and the condition of UK credit markets. If there was weakness in lending it would show up here, as such I think it is a good guide and worth a read.
For example we would expect the amount of credit available for lending to be retracting as well as the price of that lending going up. There would usually be the precursor of greater losses filtering through.
The report covers bank funding, household credit and corporate credit; the trend in all areas was a positive one, with higher availability of loans, more loans being granted and loss rates subdued.
Availability and cost of credit to UK corporates
Sources: Deloitte, Federation of Small Businesses and Bank of England calculations
Naturally it is a backwards focused report, covering the period to December 2015 and markets are of course always forward looking, but from a credit perspective there is no hint of the recession that markets are increasingly pricing in.
Lastly, this morning I read a very sensible piece of quantitative research from Goldman Sachs on the state of credit markets.
They note that this has been the worst start for high yield bonds since 1999, surpassing even 2008. They mention that credit spreads are in the 90th percentile over the past 30 years (if one excludes recessions) and that valuations are becoming increasingly attractive.
Their view (and ours) is that oil prices need to hit a bottom, which they inevitably will quite soon, which will lead to an improvement in macro conditions that will tighten spreads gradually in H1 2016 and more meaningfully in H2 2016.
Performance of oil over 3yrs
Source: FE Analytics
They also covered the highly volatile high yield exploration and production sector that has been crushed in the US, where current prices are factoring losses greater than anything ever experienced, even in CCC rated companies.
The average spread in the sector is now 2,148 basis points, which is double the spread that they reached in 2001 when WTI was just $15 a barrel.
The sector has an average duration of four years which therefore implies a cumulative loss rate of 86 per cent on a buy and hold strategy … so if one assumes a 100 per cent loss severity that means that just 14 per cent of companies will survive. That’s severe!
Anyway, our point is that while the technical position remains poor, the opportunity may well still get better, but spreads in credit markets have moved well away from fundamentals and are already offering an enticing entry point for fixed income investors.
It does feel that oil prices need to overshoot to the downside before we have a meaningful correction, so maybe $20 a barrel is possible, especially when one considers just how quickly the short base in commodities is building, but when we get there we could see a substantial rebound.
Mark Holman is chief executive of TwentyFour Asset Management. The views expressed here are his own and should not be taken as investment advice.
