Thursday, 4 September 2014
Chart of the Day - US High Yield issuance and debt outstanding
"Resilience is all about being able to overcome the unexpected. Sustainability is about survival. The goal of resilience is to thrive." - Jamais Cascio, American writer
We came across a very interesting note from UBS - Macro Keys entitled "Is the surge in US high yield issuance sustainable?"
The Chart of the Day comes from this UBS report and display US High Yield issuance and debt outstanding (bn):
- source UBS
We often hear about strong balance sheets of US corporates and their "cash" levels as the second main driver (after the Fed) for the current low volatility environment. It is indeed the case but, one must not forget about the on-going massive releveraging taking place, notably to fund buybacks via debt issuance.
As long as cash flows and margins stay on current levels, the rising gross debt levels on balance sheets do not affect ratios such as Debt/Ebitda as per the below graph from the same UBS report:
- source UBS
But, should the US experience a strong economic slowdown, you have to remember that this high level of debt can back and haunt you, particularly in the High Yield segment as in the period 2002-2003.
As a rough estimate, the US High Yield market is as big as it has ever been (superior to 1 trillion $) as per the Chart of the Day above!
In Europe, the situation is different, where the explosion in growth in the High Yield market comes from substitution from corporate loans to bond issuance due to the disintermediation on the back of bank deleveraging (which by the way is way behind the US). Existing loans in Europe are getting refinanced therefore via new High Yield issuance in the bond market, which implies that there is no significant releveraging as seen in the US so far.
So enjoy the "carry" trade but don't get "carried" away as US corporate leveraging has been on the increase due to buybacks, as shown by US equities rising strongly courtesy of multiple expansion in many instances.
We agree with UBS' concluding remarks in the sense that liquidity challenges in the High Yield space will indeed ultimately be tested should the market turn South at some point:
"In concluding, in the short run, it is possible that US corporate earnings could climb moderately, sustaining the HY market. However, over the long run, predictions for further increases would seem to be predicated on irrational expectations. We continue to believe that the corporate profit cycle is more advanced than the economic cycle, and, in turn, the fundamental underpinnings of the HY market are rather precarious. Credit investors care principally about the evolution of leverage, i.e., the outlook for profits and debt. If corporate profits prove resilient, then debt issuance will continue at will – likely resulting in an increase, albeit modest, in corporate leverage. However, if – or shall we say when – corporate profits turn lower, the increase in corporate leverage will be more pronounced, and the ability to service that debt will become a burden. The impact on issuance is less clear cut; if profits modestly decline, supply could remain frothy as companies turn to financial engineering to boost earnings. However, if the drop is severe enough, capital market conditions may deteriorate and issuance could adjust lower. Historically, credit spreads also react to large shifts in corporate leverage – quite abruptly as one would expect (Figure 4).
And, as we wrote back in August 3, the risk is that a severe downturn in credit fundamentals sparks a real panic in the US high yield market, which will likely trigger an exodus from non-institutional and crossover investors. Then, and only then, will we know the true extent of the high yield bond market's liquidity challenges." - source UBS
"The first rule of sustainability is to align with natural forces, or at least not try to defy them." - Paul Hawken, American environmentalist.