Corporate Debt’s Heated Climate Deniers
The IMF’s Global Financial Stability Report for the April meetings spotlighted higher emerging market risks, especially in private corporate and household debt as it presented a range of stress scenarios, despite the CEMBI’s 315 basis point spread and almost $100 billion in oversubscribed issuance though Q1 indicating investor calm. It calculated $1.5 trillion in fixed-income portfolio allocation as of last year with “yield reach” or triple the pre-crisis amount, and noted credit above GDP growth since 2009 with the BRICs at the late cycle stage marked by over-leverage and asset deterioration. The consumer portion is up 40 percent over the period in parts of Asia, Latin America and Turkey, as many economies still have large current account deficits and low real interest rates. Net corporate bond activity has tripled with ratios of 100 percent of GDP and more in Bulgaria, China, Hungary and Malaysia, as the number of “weak firms” with interest coverage/earnings below two now exceeds the immediate post-Lehman aftermath. In a 15-country sample Argentina, Brazil, India and Turkey are most exposed and a sensitivity analysis places $750 billion, or one-third the total, at potential loss from a combination of increased borrowing costs and sliding revenue. Currency depreciation is also a factor that can be hedged through exports and derivatives but typically protection “falls short,” according to the study. Domestic banks too may be buffeted by company strains, especially in Indonesia, South Africa and elsewhere with insufficient provisioning and write-offs that could erode Basel capital standards. Loan-deposit ratios are above 100 percent in Latin America and EMEA, and in the latter one-fifth of bank debt maturing this year is in foreign currency. China’s non-bank channels, with trusts and wealth management products in the forefront, are in their own risk class, as commercial banks hold them off-balance sheet without explicit liability guarantees and disclosure. Maturity mismatches are common and client focus is often on troubled property developers and local governments. Cross-border effects though Hong Kong lenders and the offshore renimbi market have already been felt, and although reaction to the first domestic bond default was “orderly,” Beijing’s path of market discipline and liquidity management has been “unpredictable,” the Fund believes.
Despite the corporate alarm, the JP Morgan benchmark was marginally positive through Q1 at a yield over 5.5 percent as it absorbed a pummeling from the weighty Russian component while quasi-sovereign Asian and Latin American names represented safety, and high-yield accounting for one-third the total continued to lure diversification buyers. However, along with doubts about company servicing and solvency, the ever-shifting investor base reinforces consideration of a looming crash as opportunistic US and European houses join Far and Middle East local ones in asset class dabbling. Previous participants have been excluded with the skew toward euro and private placements in recent months as the dedicated institutional and retail defensive layer lags far behind the past five years’ plausible pace of harmful emissions.
