Tuesday, December 24, 2013

High Yield Bonds - A Bubble-in-Waiting

The Federal Reserve, in its infinite wisdom, has likely created another in a long series of bubbles.  This time, their bargain basement level interest rates have led to this:

Total outstanding non-financial corporate debt in the United States has hit a new record of $9.246 trillion in the third quarter of 2013.

Here is a graph showing the growth level of corporate debt on a year-over-year basis since 2006:

After contracting by as much as 3.1 percent on a year-over-year basis in 2009, non-financial corporate debt has risen by an average of 9.4 percent annually over the first three quarters of 2013, well up from the 7.4 percent average over the four quarters in 2012.

According to the Federal Reserve's Flow of Funds database, total borrowing by the non-financial business sector has risen from $2.881 trillion in all of 2012 to $2.54 trillion in just the first three quarters of 2013.  In the third quarter of 2013 alone, business borrowing hit $980.7 billion, the second highest level since the end of the Great Recession.  It's a corporate debt feeding frenzy out there!

The Federal Reserve and other key central bank policies have allowed even the least creditworthy companies to enter the market and issue debt, largely thanks to desperate investors who are looking for yield in the current zero interest rate environment.  According to Thompson Reuters, one of the biggest problems is the issuance of high-yield debt (aka "junk bonds") around the globe.  Here is a graph showing the growth in the monthly proceeds and number of high yield debt issues for the period from 2009 to the end of the third quarter in 2013:

High yield bond volumes in Europe increased a whopping 101.4 percent on a year-over-year basis and globally, high yield debt proceeds reached $350.1 billion in the first three quarters of 2013, setting a new record for the first nine months, showing an increase of 26.9 percent compared to 2012.

Here is a graph showing how the spread between high yield bonds and the benchmark has dropped from its peak of 21.82 percentage points in 2009 to around 4 percentage points now:

Basically, investors are willing to accept a very low premium compared to most of the prior between 2000 and the present, excluding the period between 2004 and 2007, for the risk that they are taking by investing in corporations that are less creditworthy.  This gives us a sense of how desperate investors are for yield and how vulnerable they could be when interest rates rise to normal levels. 

Lastly, let's look at who is behind all of these low end corporate debt fun and games.  The number one issuer of high yield debt in both 2012 and 2013 was none other than JP Morgan.  In the first three quarters of this year, JP Morgan issued $36.8 billion worth of high yield debt (10.1 percent of the global total) in 248 deals.  Number two in both 2012 and 2013 was Bank of American Merrill Lynch which issued $30.48 billion worth of high yield debt (8.7 percent of the global total) in 234 deals.  In all, the top ten issuers, including Citi, Goldman Sachs, Morgan Stanley and Wells Fargo were responsible for issuing $240.422 billion worth of high yield debt or 68.8 percent of the global total.  Total imputed fees for putting these deals together for the top ten participating issuers?  A stunning $3.388 billion!

The wheels could come off this bus very quickly as interest rates rise when tapering really takes hold on the world's bond markets.  This obviously is another juggling ball that the world's central bankers have to keep in the air since a collapse in the world's junk bond markets could cause a catastrophic impact on the world's bond and stock markets.

Central banks - distorting yet another aspect of the economy. 


  1. I wonder how will US pay for this? Increased taxes, maybe? No income tax refund?

  2. Thanks for the insight. If I'm correct companies are gathering this money and sitting on it. With low interest rates this doesn't cost them much but gives them safety and flexibility going forward. This also helps explain why the velocity of money has dropped.