- AP News
- Abc News
Corporate debt investors face the prospect of rising defaults from China and the US junk bond market, according to Standard & Poor’s, a twin threat representing an inflection point in the current credit cycle.
China ranks as the largest corporate debt market and continues to grow, with its debt pile representing 160 per cent of its economy.
S&P estimates that companies will need to sell $57tn of debt by 2019, with 40 per cent of that from China and 21 per cent from the US.
This week Beijing reported that its economy had grown by 7 per cent for the second quarter, in line with the official target. However, the stock market plunge over the past month has sparked concerns about companies and their rising debt levels.
S&P expects default rates to accelerate, which could prompt government support for state-owned enterprises.
“Rapid debt growth, opacity of risk and pricing (partly due to bank loans dominating funding), very high debt to GDP and the moral hazard risk of the Chinese market make it a high risk to credit,” said Jayan Dhru, analyst at the ratings agency.
In the US years of low interest rates have made it easier for companies to finance their activities through loans and bonds. Companies with low credit ratings have been able to gain access to financing, as asset managers and hedge funds have sought returns above those of high-quality bonds.
“The vast volume of institutional and retail money flowing into speculative-grade bonds also suggests vulnerability,” said Mr Dhru.
S&P said four out of five new US issuers from 2012 to 2014 were companies rated B, which are deep into junk territory, while debt had largely been used to reward shareholders and for “less productive investing”, rather than capital expenditure for future growth.
With interest rates rising and money being pulled from bond funds ahead of the probable raising of the cost of overnight borrowing by the Federal Reserve this year, there is concern that lower-quality companies could be shut out of capital markets.
“There could be a significant amount of redemptions as rates do move up,” said David Tesher, a managing director at S&P. “That could lead to less funding liquidity in the market, leading to a situation where some borrowers who have been able to tap the capital markets may not have that easy access, and that’s the challenge.”
Last week $28bn flowed out of bond funds, the largest five-week outflow in two years, according to Bank of America Merrill Lynch. That could prompt defaults, although Mr Tesher said many companies had extended the maturity of their debt while interest rates have been low.
“There are still attractive yields, but the concern is around when rates do move and the pure mark to market pressure that investors will confront,” said Mr Tesher.
“Some investors are getting ahead of that now, and that is why you are seeing redemptions.”