By Ryan M. Rossner (Harvard Law School, J.D. 2019)
On February 25, the OECD published another report in its Capital Market Series, Corporate Bond Markets in a Time of Unconventional Monetary Policy, which noted both a significant increase of outstanding nonfinancial corporate debt and a simultaneous decrease in bond quality post-financial crisis. Authored by Mats Isaksson, Serdar Çelik, and Gul Demirtaş, the report drew upon a dataset of almost 85,000 unique corporate bond issues by nonfinancial companies from 114 countries between 2000 and 2018.
The report provides a detailed account of capital markets development post-financial crisis with comparisons among different jurisdictions. The authors emphasize that levels of nonfinancial corporate bond issuances have reached record highs. Global outstanding debt in the form of corporate bonds issued by nonfinancial companies reached almost $13 trillion USD at the end of 2018, twice the amount in real terms than was outstanding in 2008. The report links the expansion of corporate bond issuances to regulatory initiatives aimed at encouraging corporate bond issuances, expansionary monetary policy, and (particularly in the EU) quantitative easing. The report also forecasted a record repayment period ahead with $2.9 trillion coming due for advanced economy issuers and $1.3 trillion for emerging economy issuers within 3 years.
The US remains the largest corporate bond market and US issuers raised the most funds over the period. However, the authors found that the number of US nonfinancial issuers increased only modestly in the post-crisis era, suggesting increased issuer concentration in US primary corporate bond markets. Over the same period, Japan, the EU, Korea, and China all increased both their use of corporate bond issuances as a means of borrowing and their number of issuers. Most strikingly, the number of Chinese companies issuing bonds increased steeply from 68 issuers in 2007 to a peak of 1,451 in 2016.
Amidst the expansion, the authors found a marked decrease in bond quality. To support these conclusions, the authors pointed to a marked expansion of non-investment grade bonds, and the increase of BBB-rated bonds (the rating just above non-investment grade) as a percentage of investment grade debt (to 54% in 2018).
The report also noted a decrease in covenant protection for non-investment grade corporate bonds. The authors devised a “Covenant Protection Index” of US issuances, by looking at the presence or absence of 27 different types of covenants in bond indentures. While the index is a rough measure of covenant protection, it demonstrated a downward trend for non-investment grade bonds. The authors attribute the decrease in covenant protections to increased issuer bargaining power in a low interest rate environment, as investors have been willing to forgo certain protections in favor of higher yields.
The authors note that the combination of increased bond issuances, a “prolonged period of low issuer quality,” and “lower levels of covenant protection” for noninvestment grade bonds suggest that in an economic downturn the amount of expected future corporate bond defaults “may be considerably larger than that experienced in the financial crisis.” This report comes shortly after Federal Reserve Chairman Jay Powell, during the January FOMC meeting press conference, described the current state of corporate debt as a “macroeconomic risk,” which could “amplify” a negative downturn.
For a previous Roundtable post on distressed debt, see Edward Altman & Robert Benhenni, “The Anatomy of Distressed Debt Markets.”