Summary
By all accounts, credit markets remain on fire. 2019 is already a record year for corporate bond issuance, beating the previous record set in 2017 by a sizable margin.
Readers may be surprised to learn that contrary to 2015-2016, oil and gas companies are not leading the pack – consumer products companies are (52 issuers or ~20%).
Leveraged loans play an important role in private equity buyouts – but recently, the situation in leveraged loan land has deteriorated noticeably.
We have noticed that despite the fact that leveraged loan investors are generally considered to be quite sophisticated, such loans are in practice often re-priced quite suddenly – which is to say, investors were surprised by adverse developments befalling the borrowers.
By Pater Tenebrarum Credit Market Bifurcation
By all accounts, credit markets remain on fire. 2019 is already a record year for corporate bond issuance, beating the previous record set in 2017 by a sizable margin. Demand for the debt of governments and government-related issuers remains extremely strong as well, despite non-existent and often even negative issuance yields. Even now, with economic activity clearly slowing and numerous threats to the post-GFC recovery looming on the horizon, the occasional rise in credit spreads is routinely reversed. And yet, under the placid surface problems are beginning to percolate. Consider exhibit A: The chart shows option-adjusted credit spreads on three rating categories – while spreads on ‘BB’ rated (best junk bond grade) and ‘BBB’ rated (weakest investment grade) bonds remain close to their lows, spreads on ‘CCC’ rated bonds continue to break higher – considerably so. An increase by 473 basis points from their late 2018 low indicates there is quite a bit of concern.
It is actually rare for credit spreads on these rating classes to drift apart to such a significant extent at a time when spreads on better-rated bonds are still close to their lows. Normally, the exact opposite happens – when spreads are tightening, they also tend to tighten between the different rating classes – only when spreads are widening across the board will spreads on lower-rated bonds display a tendency to widen to more rapidly than those on better-rated ones.
This bifurcation is actually a subtle warning indicating that the credit cycle may finally be coming to its end. It is "subtle" in the sense that it is generally not yet perceived as a sign that trouble is brewing – rather, it is […]
