A survey of institutional investors by Fitch Ratings predicts that credit markets are likely to remain rocky until at least the third quarter.

Stability in the U.S. credit markets is not expected to return until the third quarter, or later, while stability in the housing market is likely even further off, according to the survey. This survey is conducted by Fitch semi-annually in partnership with the Fixed Income Forum and received responses from 88 institutional investors.

Viewed as most critical to restoring stability to the credit markets was ‘confidence in financial disclosure of mark-to-market losses,’ it noted. “Investors are clearly concerned about financial firms exposure to the current downdraft in securities prices, and want clarity as to the market losses experienced to date,” said managing director James Batterman. Also viewed as important were ‘home price stabilization’ and ‘further fed easing’, while ‘government driven remedies’ were viewed as potentially harmful or simply not important.

A weakening economy is viewed as the greatest risk to the credit markets among U.S. institutional investors. Other risk factors include ‘housing market disruptions’, failure of a financial institution or hedge fund, and geopolitical risk.

The results are a significant reversal of investor sentiment since Fitch’s June 2007 survey when shareholder-friendly activities were cited as the biggest threat, and the broader economy was not generally considered to be a large risk factor.

Respondents were nearly unanimous (99%) in their belief that the risk of a U.S. recession is either moderate or high, while fully 100% of respondents expect the default rate to increase at least moderately in 2008, with about half of these expecting the rate to move significantly higher. This is an abrupt change from the 2007 mid-year survey, in which a very small minority expected to see a significant increase in defaults.

“Softening economic growth and the credit crunch are weighing heavily on the minds of investors and understandably so,” said managing director and head of Credit Market Research, Mariarosa Verde. “Investors realize that current gloomy conditions, especially if prolonged, will provide more than enough fuel for rising defaults.”

Respondents voiced concern over the threat to credit markets from diminished liquidity. In a sharp reversal from prior surveys, respondents stressed a ‘decline in banks and other investors’ willingness to lend as the greatest risk currently posed to the leveraged loan market. “The lack of investor demand in this market will make it hard for high risk borrowers to get fresh capital or refinance existing obligations in 2008,” said senior director, William May.