Thursday, June 12, 2014

High Yield Bonds - The Next Fly in the Ointment?

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 $9.625 trillion in the third quarter of 2013.

Here is a graph showing the growth level 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 full year 2013, well up from the 7.4 percent average over the four quarters in 2012.  In the first quarter of 2014, corporate debt continued to rise at an annual rate of 9.2 percent, roughly the same as the growth rate in all of 2013.

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 $3.608 trillion in all of 2013.  In the first quarter of 2014 alone, business borrowing hit $993.1 billion, the third highest level since the end of the Great Recession.  It looks like 2014 could well be a record year for corporate borrowing if the rate of borrowing in the first quarter is continued.

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 monthly proceeds (in green) and number of high yield debt issues (in red) for the period from 2009 to the end of 2013:

Globally, high yield debt proceeds reached $462 billion in 2013, an increase of 18.8 percent when compared to 2012.

Here is a graph showing how the spread between high yield bonds and the benchmark has dropped from nearly 9 percentage points in 2009 to around 4 percentage points now:

Basically, investors are now willing to accept a very low premium for the risk that they are taking by investing in corporations that may well be less creditworthy.  This is what happens when yields on supposedly secure bonds (i.e. Treasuries, Bunds, Gilts etcetera) hover around zero.

Lastly, let's look at who is behind all of these debt fun and games.  The number one issuer of high yield debt in both 2012 and 2013 was none other than JP Morgan.  In 2013, JP Morgan issued $48.0 billion worth of high yield debt (10.4 percent of the global total) in 329 deals.  Number two was Bank of American Merrill Lynch which issued $38.69 billion worth of high yield debt (8.4 percent of the global total) in 305 deals.  In all, the top ten issuers, including Citi, Goldman Sachs, Morgan Stanley and Wells Fargo were responsible for issuing $319.6 billion worth of high yield debt or 69.2 percent of the global total.

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 as investors are forced to lick their junk bond wounds.

Central banks - distorting yet another aspect of the economy.

1 comment:

  1. The more and more I study derivatives it now appears the main goal of QE may have been to hold up the underlying value of assets that feed into and support the massive derivative market more than help the economy. QE has up to now stopped an implosion of derivatives and the resulting contagion and shock that would have spread throughout the financial system. In postponing this collapse the Fed has created a whole slew of new problems. The rise in new debt you write about in your article in just one of them. More on this subject in the article below.