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Quarter-End Insights

Mixed Performance Ahead for Credit Sector

Consumer defensive should perform admirably while our enthusiasm for the industrials sector has cooled.

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Credit Sector Roundup
During the past quarter, large banks' credit spreads widened more than the index by approximately 10 to 20 basis points. This sell-off was driven by numerous factors including: potentially more restrictive capital requirements, the looming settlement from prior mortgage and foreclosure practices, the possibility of a weakening economy, and comments from the rating agencies about potential downgrades because of the loss of "too big to fail" status. One rating agency mentioned that some banks could even be lowered three to five notches when TBTF is removed. Compounding all these domestic issues was the looming possibility of a Greek sovereign debt default.

Overall, while many of these concerns are valid, we feel that they are accurately reflected in the relatively wide spreads of banks. More restrictive capital requirements on large banks would reduce overall profitability, but they would also serve to reduce the risks faced by bondholders. Although the economy has shown some signs of slowing, banks have not seen an increase in nonperforming loans and in fact have been able to reduce the amount of the nonperforming loans. Banks have also been steadily increasing their capital positions. Citigroup, for example, has raised its Tier 1 common ratio more than 200 basis points in the past year to 11.3%. We expect banks to continue building their capital ratios and should have little difficulty absorbing the effects of a slowing economy.

David Sekera does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.