Monday, 12 October 2015

Macro and Credit - Bouncing bomb

"To find relief in what has been, we must make ourselves eternal." - Violette Leduc French writer
While watching with interest the strong "relief rally" in commodities, High Yield credit seeing strong inflows as well as Investment Grade and equities alike, we thought we would this week again use an explosive analogy in similar fashion to our previous one. 

This time around our choice fell on the principle of the bouncing bomb given the strong rebound seen as of late in various asset classes. The principle of the bouncing bomb is as follows: The bomb is dropped close to the surface of a lake. Because it is moving almost horizontally, at high velocity and with backspin, it bounces several times instead of sinking. Each bounce is smaller than the previous one (in similar fashion to QEs, more on this in our conversation). The "bomb run" is calculated so that at its final bounce, the bomb will reach close to the target, where it sinks. A depth charge causes it to explode at the right depth, creating destructive shockwaves (market melt-down). 

Aeronautical engineer Barnes Wallis' April 1942 paper "Spherical Bomb - Surface Torpedo" described this particular method of "ricochet" attack in which a weapon (QEs) would be bounced across water (markets) until it struck its target, then sinking to explode underwater, much like a depth charge (asset bubble). This method was used during Operation Chastise in 1943 when the RAF's 617 Squadron attacked the Möhne, Eder and Sorpe dams in Germany with Barnes Wallis's "bouncing bomb. This Operation was re-enacted in the famous 1955 British film "The Dam Busters" starring Michael Redgrave and Richard Todd, based on the 1951 book of the same name by Paul Brickhill.

On a side note we find it amusing that a remake of the "Bouncing Bomb" has reportedly been in development since 2008, but has yet to be produced as of 2015. Maybe they are not looking in the right places, because if they would look more closely at financial markets, they would find out that the "Bouncing bomb" has been developing indeed since 2008 in the various iterations of QE but we ramble again...

Before we go into the nitty gritty of our Macro and Credit related conversation where we will discuss if this rally has legs or not and what to expect in the coming weeks and months, we would like to point out that in our short end of September conversation "A couple of charts summarizing recent credit markets violent moves" we clearly indicated that in credit a rally was on the card:
"Interesting entry points in cash bonds, if one believes in continuous Central Banks liquidity support and no recession. "
We also added:
"As we posited in our last conversation the US "releveraging" has been fast and furious  which is not yet the case in European credit (far less "leverage" and "buybacks").
Therefore on European Investment Grade Credit as well as European High Yield, we have reached some interesting "entry" points when it comes to "cash credit". This could be an enticing play for investors "gutsy" enough to "front-run" a buying spree from the ECB on a much greater spectrum of corporate bonds than just a few issuers (which so far have been included in their buying program)." 
While we mostly refrain from making direct trade recommendations in our musings, we do give once in a while "directional" hints that makes sense from our tactical point of view.

The rally seen so far in credit in both cash and synthetics has been confirmed in the rapid tightening seen in credit CDS indices since the roll on the 28th of September as reported by DataGrapple:

"Credit indices have tightened as fast as they widened after the roll. While they were 20% wider 10 days ago, the new series (25 in the US, 24 in Europe and Asia) are now roughly trading at the level at which they were issued 3 weeks ago." - source DataGrapple
While the "Bouncing Bomb" has been a welcomed "relief" for some, and given each bounce is smaller than the previous one, in this week's conversation we will look at the overall picture for Macro and Credit given the outcome seems more and more complex with a continuation of "sucker punches" or large "standard deviation" price movement such as recently witnessed in E.ON and RWE (up today by 9.87% and 12.78% respectively).


  • About the Emerging Markets (EM) rally: High Yield, particularly LatAm is still in the crosshair with Brazil leading
  • Do we still believe the Credit Cycle is turning? A resounding, yes we do.
  • Final charts - Looking for a Bouncing bomb? Tenfold increase in USD-denominated EM corporate bonds since 2009

  • About the Emerging Markets (EM) rally: High Yield, particularly LatAm is still in the crosshair with Brazil leading
While once again the "Bouncing bomb" has done a nice "ricochet" as of late thanks to the Fed's holding pattern which is in effect suspending the "capital outflows" and "execution" for some, we believe that's this time around this "rally" doesn't have a lot of legs given, as per our previous High Yield related note, cost of capital is on the rise.

In September we saw a respite in terms of defaults in the EM HY space as reported by Bank of America Merrill Lynch in their EM Corporate Monthly report from the 2nd of October entitled "Living on a prayer":
"No defaults in September takes EM HY default rate to 3.3%
The EM HY corporate LTM default rate rose to 3.3% in September from 3.2% at the end of August, while the US HY corporate LTM default rate fell to 2.6% from 2.7% between
September and August. EM HY corporate defaults have picked up over the last year (the EM HY corporate default rate was at 1.9% at the end of Sept 2014) but remains contained and far below levels reached in Sept. 2009 (10.1%).

YTD, 14 EM corporate issuers have defaulted, which compares to just 9 defaults in all of 2014. On a trailing 12mo basis, there have been 18 EM HY defaults. Regionally, LatAm accounted for 7 defaults (6 from Brazil alone); 6 defaults in Asia (4 from China) and 5 defaults in EMEA. The regional LTM HY default rate as of the end of September was: LatAm HY 4.5%; Asia 3.6% and EEMEA HY 1.7%." - source Bank of America Merrill Lynch
Thanks to the Fed holding's pattern there is indeed potential for the "Bouncing bomb" to last until year end for EM credit and the high beta High Yield game, but, looking at the looming debt maturities, liquidity profile and FX exposure for some LatAm corporate debt issuers, rest assured that 2016 will not be smooth sailing. On that specific point we read with interest UBS take in their LatAm credit strategy note from the 9th of October entitled "Looming debt maturities, liquidity and FX exposure":
"Looming LatAm corporate debt maturities by country
LatAm corporates (including banks) have more than US$115 bn (according to Bloomberg) in debt (external and local) maturing in FY15 and FY16 of which about 55% is denominated in US$. The total amount due including FY17 doubles to US$230 bn with 56% in US$. Almost half of the debt due through FY17 is from Brazilian companies with US$113 bn, followed by Mexico with US$57 bn. Almost half of the Brazilian debt coming due is denominated in US$. While the US$ debt due in Brazil is large in absolute terms, the percent in US$ of total FY15-17 maturities from other LatAm countries is higher: Venezuela 97% of the US$16.6 bn coming due, Chile 73% of the US$16.5 bn, Peru 85% of the US$7.9 bn. We examine LatAm Corporates' upcoming debt maturities, certain potential liquidity issues, and US$ debt exposure.
Looming LatAm corporate debt maturities by issuer
The non-bank corporates with the most coming due in the near-term, as can be well imagined, include quasi-sovereign oil companies Pemex and Petrobras, followed by America Movil. See charts on page 2. Fortunately, liquidity ratios (LTM EBITDA + Cash / STD / LTM int. exp.) for these three companies are high at 7.2x, 2.8x and 3.5x (1H15), respectively, meaning they can all adequately meet their financial obligations at least through 1H16. Including financial obligations for 2H16 would lower Pemex' liquidity ratio to a still very high 5.8x, have negligible impact on Petrobras and lower America Movil's liquidity ratio to a still adequate 2.5x as it has US$2.75 bn coming due September 2016. Oi is next among LatAm corporates with US$2.8 bn due through FY16, but has a reasonable 1.8x liquidity ratio (1.6x including 2H16). The LatAm banks with the most coming due over the next five quarters are Santander Brasil, Bradesco and Itau with US$4.5, 3.6, and 3.4 bn, respectively.
Ten corporates (non-banks) with largest debt maturities FY15-17
The ten corporates with the most US$ debt coming due FY15-17 are PDVSA, Pemex, Petrobras, Cemex, America Movil, Oi, Braskem, Pacific E&P, Vale, Minera Frisco. CCR, Marfrig and Gasoducto Sur Peruano would be on the list if we exclude Quasi-sovs.

Foreign currency debt exposure
The significant depreciation in LatAm currencies has led to investor concerns related to exposure of LatAm corporates to foreign currency debt. Key issuers examined that are exposed to US$ debt without indirect hedges include Petrobras, CSN, Oi (although Oi mgmt states that foreign debt is hedged, but we would like confirmation on EUR debt), and Entel. Key issuers with minor FX mismatches include: Ecopetrol (which recently implemented hedge accounting), CMPC, BRF, Gerdau, Marfrig (0.7x in US$) and ICA. Key issuers with greater US$ revenues than debt exposure include Vale (13% of debt in BRL, hedges against weaker US$), Odebrecht E&C, Pemex. Finally, key issuers of bonds with balanced debt and revenues include: Fibria, Klabin, SCCO, JBS, and Minerva." - source UBS
So yes, while the recent "bounce" is enticing for investors to "carry on" or re-initiate the carry game which so far has been validated by recent huge flows seen in US High Yield, we do think that the risk, given the lateness in the credit cycle and credit game, does less and less justify the "rewards" or the exposure, particularly in a positive correlations world with larger and larger "Bayesian" price moves with significant Standard Deviations" (SD) impacts on the VaR models. Nonetheless, European leverage in the credit space is lower than in the US, which means European credit still appear to us more attractive from a relative value perspective.

In terms of US High Yield, ETFs have recently posted humongous inflows thanks to the Fed's holding pattern and as reported by Bank of America Merrill Lynch High Yield Flow Report from the 8th of October entitled "Record inflows into HY ETFs":
"US HY ETFs post largest ever dollar inflows
US HY had inflows of $1.16bn (+0.6%) for the week ended October 7th. This was driven by massive inflows into HY ETFs ($1.73bn, +5.3%), partially offset by a $574mn (-0.3%) outflow from non-ETFs. The enormous ETF inflow is the largest ever in dollar terms (although we saw a similar though slightly smaller $1.6bn inflow in July), and the greatest since December 2008 in percentage AUM. 

The massive inflows for ETFs were fueled by a big week for equity returns, where the S&P 500 gained in 4 out of the 5 trading sessions on the week. Non-ETFs on the other hand, posted outflows of -$574mn as global macroeconomic uncertainty continues to play out. High grade funds had a minor $315mn outflow on the week. The biggest loser this week in terms of %AUM was non-US high yield, which had a $3.65bn outflow (-1.5%). Loans had their 11th consecutive week of outflows, losing $337mn this week to bring their YTD total outflows to $14.30bn (-10.2%).
Other fixed income funds reporting flows were EM debt (-$639mn), munis (+$622mn), and money markets (+$20.87bn). In aggregate, fixed income saw a $3.01bn (+0.1%) net inflow this week. Equities, on the other hand, had net outflows of $4.09bn (-0.1%)." - source Bank of America Merrill Lynch
While we have been "tactically" short-term "Keynesian" bullish, when it comes to our recent "credit" call, we remain long term "Austrian" bearish, particularly when it comes to our "credit" related "Bouncing bomb" analogy and the High Beta gamblers. We would recommend moving into a higher quality spectrum in terms of "credit ratings" and exposure.

As we posited last week in our conversation "Sympathetic detonation", our late credit cycle indicators are clearly indicating how late the credit game is:
"Every single time the "CCC Credit Canaries" have been less and less "able" to tap the primary markets, the High Yield default rate went significantly upwards. As we have told you before, cost of capital, "hiking" or "not hiking" by the Fed is going up in an environment where issuers have weaker fundamentals, falling EBITDA and higher leverage which is not a good "credit recipe" for "total return players" (which by the way have a significant exposure in dollar terms) as well as for "forward returns" on the asset class itself." - source Macronomics
This leads us to our second point where we re-iterate our views that we are running late in the "credit" game thanks to "overmedication" from our "omnipotent" central bankers.

  • Do we still believe the Credit Cycle is turning? A resounding, yes we do.
While last week we indeed mused on various metrics, particularly in US High Yield and the CCC bucket in particular being our favorite "Credit Canary", we would like again this week to point at other signs that indeed "something is rotten in the state of High Yield" to paraphrase Shakespeare's Hamlet masterpiece.

In the below Bank of America Merrill Lynch chart depicting High Yield/Loan New issue "Uses of Proceeds", you will see for yourself on continuation to last week where we highlighted the rise in Leverage and weakening EBITDA, that all is not well indeed in the "state of High Yield":
- source Bank of America Merrill Lynch
Whereas equity "monetization" is on the rise, there is no CAPEX whatsoever in the "Uses of Proceeds" from "new issuance". In fact Equity "monetization" in the High Yield space in the US has been on a meteoric rise since 2008 and cheap "credit" has also been largely used to push back to maturity wall to a later stage...

We could also point to another chart from Bank of America Merrill Lynch that clearly shows the deteriorating trend in US High Yield. For instance the chart below shows the trailing 3 month migration rate for US Investment Grade and US High Yield:

-source Bank of America Merrill Lynch.

And, when it comes to our "bold statement" relating to the lateness in the credit game, we would like to point out to UBS's take from their Global Credit Strategy note from the 7th of October entitled "Which firms could be shut out of capital markets?":
"Credit Cycle Turning? Non-Bank Liquidity Hits Multi-Year Lows
The recent sharp selloff in US corporate credit has amplified concerns about the staying power of the credit cycle. However, many investors point to a well-capitalized banking system and easy bank lending standards as a source of corporate strength and confidence in the current cycle. We believe this is insufficient in today's post-crisis environment. Non-bank credit dwarfs bank credit as a funding source for US corporates. The implication is that an assessment of the state of non-bank lending conditions is needed to gauge the health of today's corporate credit cycle. We utilize the bond market and trade finance as two areas where we can get timely reads on non-bank lending conditions, and both signal a tightening of lending standards ahead. Low quality speculative grade net issuance has fallen sharply in a replay of late 2007 as the stimulative effects of past Fed quantitative easing wears off. Non-bank trade finance has also decreased to its weakest level since September 2011. While bank lending standards currently indicate benign conditions, this may change in short order. First, Federal Reserve Bank lending standards are only available through Q2'15; it is likely that the summer market volatility has negatively impacted conditions. In addition, our proxy for non-bank lending has reliably indicated tightening bank standards for corporate borrowers in the past, with a one quarter lead. In short, we would expect bank lending standards to tighten through the end of this year. If our analysis is correct, today's elevated level of US investment-grade and high-yield credit spreads will persist, and default rates may rise materially through 2016." - source UBS
As we pointed out last week in our conversation "Sympathetic detonation":
"Every single time the "CCC Credit Canaries" have been less and less "able" to tap the primary markets, the High Yield default rate went significantly upwards. As we have told you before, cost of capital, "hiking" or "not hiking" by the Fed is going up in an environment where issuers have weaker fundamentals, falling EBITDA and higher leverage which is not a good "credit recipe" for "total return players" (which by the way have a significant exposure in dollar terms) as well as for "forward returns" on the asset class itself." - source Macronomics
UBS also underlined in their report the significant fall in low quality speculative grade issuance and its similarity with 2007. In their note, UBS also made the following very interesting points which validates our early warning indicator being the "CCC fall in issuance level canary" depicted last week:
"The recent selloff in US corporate credit has amplified concerns about the staying power of the current credit cycle. Investors have been inundated with risk-off events over the past weeks, from falling commodity prices, weakening EM economies, monetary policy uncertainty, and increasing market illiquidity. Throw in rising idiosyncratic company issues across sectors from Glencore (Mining), Sprint (Telecom), Valeant (Health Care) and Volkswagen (Auto) among others, and it is clear that the latest selloff is different. This is not just an energy story, but a broader conversation about the credit cycle and our place in it (Figure 9).
Our framework for viewing the corporate credit cycle focuses on the supply side, as we believe the retrenchment of lenders from extending new credit is a reliable leading indicator of future refinancing risks for borrowers, as we discussed in Forecasting the Credit Cycle. On this note, banks do continue to ease lending standards, which has generally indicated lower credit spreads and default rates 6 months and 12 months forward, per our modelling work. However, there are concerns that a pure bank measure may be inappropriate for gauging the health of the corporate credit cycle in today's environment, given non-bank sources of credit, such as the bond market. US Non-Financial Corporate Bond Liabilities total $4.7tn vs. $0.8tn for Non-Financial Corporate Bank Loans (Figure 10).

Since 2008, the bond market has grown 57% vs. only 7% for bank loans. Simply put, tracking bank lending standards is not sufficient to gauge how the corporate credit cycle is evolving. Today is a case in point: Non-bank liquidity has fallen to cycle lows and points to a late cycle trend if volatility continues to rattle markets.
We utilize two timely measures of non-bank liquidity in this piece that have historically helped to predict the end of past credit cycles. The first comes from the bond market. We utilize changes in net issuance (proxied by Gross Issuance – Scheduled Maturities) for low quality credits to determine if lenders are starting to ration their existing liquidity to higher quality borrowers. This is often the first clue that investors are shifting to a “return of capital” from a “return on capital” mindset. Our analysis suggests it is actually the lowest of low quality issuers (B-rated and below) that provides the first leading signal that credit stress may lie ahead, as Figure 11 illustrates. 
Worryingly, this chart is flashing red. While BB net issuance has held in quite well, B-rated and lower net issuance has plunged in a replay of late 2007, as investors cut back in the face of growing default risk and rising illiquidity. And stripping out the energy sector from this chart makes no difference; ex-energy low-rated issuance is drying up too. It is no coincidence in our view that HY issuance has struggled post the Fed's QE programs. Without the Fed injecting liquidity into the market, investors have been forced to focus more on credit risk, and they like less of what they see here. Even in terms of overall corporate credit creation, the US credit impulse (i.e. the change in credit growth) has been weakening for some time post-QE (Figure 12).
Importantly, this is not just a high yield bond story (Figure 13). 
The US loan market has seen a precipitous drop in issuance due to a Fed-led regulatory crackdown that began in 2013 to thwart the occurrence of poor underwriting standards (excessive leverage, absence of financial covenants, weak repayment possibilities). EM HY net issuance has also been on a downward trend since the end of QE3, raising concerns about how a looming maturity wall will be financed. Refinancing risks for speculative grade credits abound if this general trend lower in issuance persists.
Our second non-bank proxy is the NACM Credit Managers Index (CMI) on Trade Finance. This monthly index, constructed similar to the PMI index, gauges nonbank trade finance (the financing of receivables and inventories) from 1,000 US credit managers at individual companies and finance firms, rather than from banks (who are generally smaller lenders of this credit). September’s index reading dropped sharply from 54.2 in August to 52.9 in September, which represents the lowest reading in the survey since Sept 2011. There was broad weakness reported across both the manufacturing and service sectors, particularly with respect to debtor-creditor tensions (Figure 15). 
Invoice disputes rose, borrowers took longer to pay, and more lenders enlisted the help of collection agencies to collect on outstanding debt. While this survey is choppy month-to-month, its trend has been a good forward predictor of credit spreads; hence these poor results bear watching (Figure 14).

Previous readings of the survey from April to July had showed an improvement in conditions. We will need to analyse this data post-September to see if the recent down move continues to signal a worsening phase in tradefinance lending.
As mentioned before, the health of the banking sector appears reasonably strong at this juncture. Bank lending standards through Q2 ’15 remain solid and bank NPLs continue to decrease, with no sign of levelling off (Figure 16). 
This is a definite positive, but we worry it overstates the health of the credit cycle. First, bank lending data is lagged and only goes through Q2'15 at the moment. In the past bank lending standards have been reasonably correlated with the average VIX over the quarter; the official read on bank lending for Q3’15 may be less rosy than in Q2 (Figure 17). 

Second, the easing of Q2 bank lending standards was driven relatively more by competitive pressures than belief in a stronger economic outlook, as discussed in Do Improving Lending Standards Signal Hibernation For Credit Bears? At some point, acute loss risks will trump competitive pressures. Finally, even the well documented drop in liquidity for leveraged loan issuers was not picked up by the Fed SLOS survey, highlighting a potential blind spot in aggregate bank lending conditions.
What do our non-bank measures tell us about the future level of bank lending, and ultimately credit spreads and defaults, per our model framework? Utilizing quarterly data back to 2001, we build a model that predicts SLOS based on the level of the CMI index and low-quality HY bond net issuance (Figure 18). 

The fit is good (R-squared of 68%) as we expected, highlighting that bank and non-bank liquidity evolve similarly through time. However, we would note that our non-bank liquidity measure generally leads our bank liquidity measure by one quarter. The exception is during the financial crisis, where the banking sector was clearly the epicentre of the problem. The implication of this model is that bank lending will tighten from a healthy 6% of banks easing standards in Q2'15 to 14% of banks tightening standards in Q3 '15. This would be a significant move; these levels would imply HY defaults near 4.8% by Q3'16, even without accounting for specific stresses impacting the energy and materials sectors. Our fair value estimate for IG/HY spreads would be 183bps and 631bps by Q1'16 respectively vs. current spreads of 170bps and 684bps (Figure 19). 

In essence, while today's elevated spreads appear cheap, they only represent fair value. On the positive side though, we believe further spread widening would only be warranted with a systemic-type event, likely originating from even lower commodity prices, a renewed strengthening of the dollar, or a further deterioration in EM growth.
In sum, we believe that non-bank lending standards illustrate an overall tightness in US financial conditions that signal a downside growth risk to the US economy. While bank lending standards are healthy, we ultimately believe this misdiagnoses the pulse of the corporate credit cycle. Nearly all of the additional financing provided to nonfinancial corporates has come from non-bank sources, post-crisis. And expecting the banking system to meaningfully pick up the baton from a nonbank slowdown is unrealistic in today's highly regulated environment. In short, non-bank liquidity has been the main driver of the corporate credit cycle post-crisis, and there are now early signs that it is evaporating." - source UBS
There is indeed growing downside risk to the US economy thanks to rising overall tightness in US financial conditions but, we would add it is globally the case. The fall of EM FX reserves is as well a growing sign of tighter financial conditions.

So, overall, yes, clouds are lining up but when it comes to credit and the current "Indian summer" there is indeed room for additional short term spread tightening over the coming weeks. On that note we agree with BNP Paribas's recent take on this subject from their Global Credit Plus note from the 8th of October:
"Europe - Step it up
Given the FX moves in EM, we feel encouraged to stay constructive on European
Credit given the FX tailwind and potential upcoming ECB expansion. We dig a little deeper into our Leveraged Loans (constructive) and HY (less so) portfolio views this week. We recommend investors rebalance towards BB away from B in HY given the significant compression this year. We maintain our Overweight BB in Leveraged Loans. Supply should pick up moderately but given the basis underperformance we think Cash should hold its own relative to CDS. The Chinese Communist Party meeting needs to be monitored for any signals.
US - That old dog can still huntIn light of last week’s valuation move and the surprisingly weak nonfarm payrolls we have slightly revised our expectations for US Credit. We now expect spreads to tighten over the next 2-3 weeks before the combination of weak US corporate outlooks and unconvincing Chinese stimulus proposals reverse the trend. We also detail our expectations for Q3 15 US corporate earnings, including takeaways from early reporters and profit warnings." - source BNP Paribas
In the light of the above there are indeed more room for the "Bouncing bomb to "ricochet" a little bit further before sinking and triggering the collapse of the "credit" dam but that's another story...

For us, the BIS, our Rcube friends and now the IMF, a growing worrying concern has been indeed the significant rise in USD-denominated EM corporate debt.

  • Final charts - Looking for a Bouncing bomb? Tenfold increase in USD-denominated EM corporate bonds since 2009

When it comes to a definite "Bouncing bomb", in similar light to the most recent IMF report, we still believe as per our previous conversation that indeed USD-denominated EM Corporate debt is the definite one as highlighted in the chart below from Société Générale Cross Asset Research note from October entitled "What if ? Lost decades":
"Emerging market corporate debt has exploded since the start of the global financial crisis. In its recently published report on Corporate Leverage in Emerging Markets, the IMF calculates that EM corporate debt has risen from less than 50% of GDP in 2008 to almost 75% now – with Chinese corporate debt alone rising from less than $8tr to more than $16tr over the same period.
So corporate debt has become the Achilles heel of the emerging markets. But the news gets worse. Emerging market corporates have not only borrowed aggressively – they have borrowed in dollars. A report from the BIS earlier this year made the point that most of the dollars created since 2007 have either been lent to the US government, or to non-US corporates – particularly in emerging markets. Both the BIS and the IMF reports make the point that corporate bond issuance has grown as a percentage of total debt. 
So it should come as no surprise that hard currency EM corporate debt has been growing by leaps and bounds. Chart 1 (based on the iBoxx USD-denominated hard currency debt index) shows the growth in outstanding dollar-denominated corporate bonds since 2009:

Three trends stand out:
  • Total corporate debt has risen at a compound annual growth rate of more than 30% since 2009. The hard currency corporate debt market in 2009 was roughly the same size as the government market; it is now twice as big.
  • Asian debt has risen slightly faster than debt in EEMEA and Latam, and now represents roughly two-fifths of the universe, up from a quarter in 2009. By contrast EEMEA debt have gone the other way, and Latam debt has stayed at one-third of the total.
  • Chinese debt has ballooned to almost 60% of all Asian corporate debt, while Russian debt has gone from almost two-thirds to one-third of EEMEA debt. Brazil still represents between a third and two-fifths of all Latin American debt.
Is growth in corporate debt a worry? It has certainly boosted balance sheet leverage, as the IMF’s recent report notes. In Chart 2, we show the evolution of the debt/equity ratio from the companies in the iBoxx EM index.
The chart shows that balance sheet leverage has roughly doubled, and is now comparable to the levels in the US market (at 32%). The data from the start of this century is spotty, so we wouldn’t necessarily be sure about the magnitude of the increase – but the trend at least is clear. 
Nevertheless, part of the rise in leverage in the index may be due to changes in the index.
Charts 2 and 3 compare the composition of the iBoxx index by industry sector in 2009 and now.

Six years ago half the companies in the index were commodity and mining companies; now that percentage has shrunk to a third, with financials making up another third. The rather worse news is that cyclicals, which normally have low levels of balance sheet debt, have overtaken non-cyclicals, like telcos and utilities.
All the same, even with the changes in the index, the rise in balance sheet leverage is worrying. And given the focus in the press, i.e. supranationals and investors in the EM corporate sector, one would have expected this sector to lead the recent EM sell-off. But it hasn’t." - source Société Générale

One might wonder why it hasn't. Société Générale in their report had an interesting explanation tied to "liquidity":
"EM corporate markets are far less liquid than EM FX. As a result, EM investors could simply be selling the currency as a proxy for the corporate. In this case, the market’s woes could be just beginning." - source Société Générale
If indeed the Fed finally makes up its mind and finally decides to "normalize" we are indeed bound for more bouncing, more ricochet, before the EM USD-denominated Bouncing bomb set-off à la Dam Busters...

"With bombs and fires, you get only one mistake." - Red Adair
Stay tuned!


  1. EM USD credit monster. Who is the bigger mug - The issuer who will go under and default or the buyer who will lose all their investment?

    1. David Goldman from Reorient Group summed it up nicely in his last piece: "Emerging market corporations, particularly in Latin America and Eastern Europe, played the global levered carry trade with their own balance sheets. In the past, hedge funds borrowed in cheap funding currencies and lent to high-interest venues in emerging markets. Quantitative easing made it possible for emerging market corporates to go directly to the capital markets and borrow cheap money themselves in dollars or euros and convert it into local currency. As soon as the Fed signaled a future rate rise, the dollar soared, and the nominal dollar value of world exports plunged—by 12% y-o-y as of July. Emerging market economies were squeezed and equities collapsed. As soon as the market concluded that the Fed wouldn’t do anything soon, EM equities bounced back."

      The biggest mug are the issuers courtesy of Fed's generosity, of course the buyers (mostly retail punters) will lose part of their shirt on this...while distressed players are already carving their knives!


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