Creditflux Newsletter

At this time, it is tempting to look back at the year just gone and reminisce – particularly as 2009 was extraordinary. It is rather more difficult to look forward and make a few predictions for 2010. But Wolseley isn’t one to shirk a challenge.

Banks will continue to shrink their balance sheets in 2010. Continued uncertainty about regulation and prodding to raise new capital will ensure that most banks remain defensive. While the originate and distribute model is not as fashionable as it was before 2007, the rising cost of capital will encourage banks to search for new variations on the originate and distribute theme.

With banks still in balance sheet retrenchment mode, 2010 will be the year of alternative investors. Banks have left a gap in the market for the provision of balance sheet intensive services like underwriting. BlackRock’s ambitions to build an investment banking type model with institutionalized distribution agreements will fill a small part of that gap. Look for pension funds, insurance companies and pools of private capital (please don’t call them hedge funds) to step forward also. A “buy side” investor will figure in an elevated position in some credit underwriting league tables.

With the traditional division of roles between buy side and sell side breaking down, underwriting fees and bid-offer spreads will come under pressure. Central counterparties will extend their reach to other products in the credit markets and will open themselves to use buy side accounts on the same or similar terms to those available to the sell side.

Sell side firms will specialise. More banks will withdraw from market making. This environment is rich with opportunities for inter dealer brokers. Outfits like Evolution will continue to prosper.

Under pressure from regulators, banks will become smaller and more local. National taxpayers will not contemplate another bailout of an international bank. Building diversified portfolios will become the preserve of the asset management industry.

Wolseley’s crystal ball becomes brighter when it comes to predictions for the future of the structured credit market. The structured credit market never really went away. It just hibernated in the official sector, with many of the techniques that central banks and treasuries used to support the markets over the last 18 months coming straight out of the structured finance play book.

As private investors regained their composure through 2009 we have seen the re-emergence of a pipeline of structured credit deals. No more innovation for innovation’s sake, no more complexity on complexity, and Lord Turner will be pleased to hear that the recipe for CDO squareds has been lost, but there is no doubt that the world needs a healthy securitisation market to ensure credit reaches parts of the economy that other markets can’t reach. Without it growth will be anaemic, tax revenues will stagnate and politicians won’t win elections.

And whither spreads? We won’t see a repeat of the rally of the second half of 2009, but in Wolseley’s view the outlook for credit remains sound.

Investors will need to be discerning, though. The aftermath of the crash has left some credits fundamentally damaged and they need to be put out of their misery. But with liquidity from the official sector secure until growth is firmly established, and with regulatory headwinds balanced by pragmatism from politicians, 2010 will be positive year for credit.

Wolseley is a leading practitioner in the credit market. Feedback is welcome at wolseley@creditflux.com