The correction is on the way

In Canada, the share price performance of the major banks belies the influences of global monetary tightening, higher energy prices, a stronger Canadian dollar and weakness in the US auto and housing sectors. Moreover, the threats posed by the US fiscal and trade deficits continue to cast long shadows over the markets. The Q4 Bank financial releases show that these effects are starting to be reflected in rising commercial and corporate loan loss experience. 

We anticipate that Loan Loss experience in North America and Canada will continue to deteriorate. We are not alone in this view:

• Default rates are currently at about a tenth of the average of the last 20 years . Alchemy Partners ’s Jon Moulton has said that he believes default levels are set to soar in the coming years. “The debt markets have been very loose and low on credit standards.”
• While default rates may be relatively low now, 76% of those responding to a recent Turnaround Management Association survey believe there will be a significant increase in the debt default rate by the end of 2007.
• U.S. corporate bankruptcies will rise by 17 percent in 2007 after falling an estimated 20 percent in 2006, Global Insight, a financial forecasting firm, predicts.
• Noted Investor Wilbur Ross expects default rates to rise as high as 7% or 8% in 2008, and many restructuring experts agree. “I think when [a correction] comes, and it is coming, it’s going to be a big one,” says Jay Goffman, a partner in the corporate restructuring department at law firm Skadden Arps.
• S&P warned in December that “the average debt payment burden on LBO’s is four times above the normal safe level.” In house credit strategist, Blaise Ganguin, said: “There is very little margin for error. Any hiccup, whether in currencies, commodity prices, or wage settlements could push these companies over the brink.”

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