DEBT ISSUANCE

Debt Issuance is when companies or governments raise funds by borrowing money from bondholders. The company or government borrowing the money (issuing the debt) agrees to pay the lender (the bondholder) a set interest rate over a defined period. This payment, which is usually made monthly or quarterly, is sometimes called the coupon.

At the end of the period, the borrower pays back the lender in full.

A Debt Issue is a financial obligation that allows the issuer to raise funds by promising to repay the lender at a certain point in the future and in accordance with the terms of the contract. It is a fixed corporate or government obligation, such as a bond or debenture.

Kinds of Debt Issuances

The two most common kinds of debt issuances are governmental or corporate. Federal, state and local governments issue debt when they need money for capital projects such as building roads or schools, or for day-to-day operations. These debt issuances are called municipal or Treasury bonds. Companies issue debt to fund capital projects, acquisitions and more. These are called corporate bonds. Debt issuance is essentially a fancy term for borrowing money through the capital markets.

Setting the Interest Rate

A company or government is assigned a credit rating by a firm such as Moody's or Standard & Poor's. This rating determines the interest the entity will have to pay when issuing debt. Companies and governments with stable finances and sound balance sheets attain a higher credit rating than those with poor finances. A lower credit rating means the interest rate on the debt issuance will be higher, so it will cost more for the company or government to issue the debt.

The Process

Investment Banks sell the company's or government's debt in the form of bonds on the bond market. The interest rate is set based on the credit rating and on demand from investors. Institutional customers such as pension funds or mutual funds are big buyers of debt issuances, though individuals can also buy the debt. After this process occurs, the borrower receives the cash from the debt issuance and the lenders receive the bonds.

Bonds Trade Hands

After the debt is issued, the borrower has a set interest rate that it has to pay for a certain length of time (often 10 to 30 years). But the bonds that it issues frequently trade hands on the open market, with prices rising and falling. The price the buyer pays affects the interest rate for the buyer, but the debt issuer continues to pay the same interest rate as was established when the bonds were first sold.

Debt Paid Back

Each debt issuance has a certain term, often 30 years. At the end of that period, the borrower is required to pay back the lender's principal in full. The lender also received the interest payments (coupons) throughout the term of the debt issuance. Sometimes interest rates will fall during the term of the debt issuance, and the borrower can buy back the bonds (call them) and issue new debt on cheaper terms.

Global debt hits a new record at $247 trillion

Global debt has hit another high, climbing to $247 trillion in the first quarter of 2018, according to a report published Wednesday. Of that figure, the non-financial sector accounted for $186 trillion.

The debt-to-gross domestic product (GDP) ratio has exceeded 318 percent, marking its first quarterly rise in two years, the report by the Institute of International Finance (IIF) said. This is amid record levels of corporate and household debt in many mature markets.

The unprecedented debt load is one of several investor concerns, in addition to worries about the Federal Reserve’s monetary policy tightening and the impacts of a trade war.

It's the debt in the corporate sector that market players should be worried about.

The corporate sector is highly leveraged and could be very vulnerable to higher interest rates. A primary reason corporate debt-to-GDP is so high is thanks to interest rates being historically low due to quantitative easing and forward guidance. Firms have used artificially low rates to borrow in the capital markets and only buy back stock in the equity market. The inherent instability of debt over equity financing suggests that the next downturn could hit investment spending unusually hard.

Market Volatility and likely inflation due to a trade war, which is currently brewing between the U.S. and China, could in this case have an outsized effect on assets, analysts have cautioned. But, so far, markets have been surprisingly resilient and have done a good job of becoming more and more desensitized at the trade rhetoric.

Other high-profile figures have issued stark warnings about the global debt load. The IMF’s first deputy managing director, David Lipton, told CNBC late last year that high debt and low interest rates posed the greatest market risks.

Non-U.S. borrowers and emerging markets are also looking at particular risks, according to the IIF report, especially as yields and interest rates rise, making refinancing and repaying dollar-denominated debt significantly more expensive.

Credit Investors

Credit investors ARE NOW worried there won’t be enough liquidity in a downturn are taking bigger steps to avoid getting stuck with hard-to-trade corporate bonds are hedging in the CDS markets.

Action in Credit Default Swaps (CDS)

They’re snapping up index derivatives -- synthetic products that are easier to buy and sell than cash bonds -- in increasing numbers as a way to stay light-footed should the big one hit. Volume on Markit’s CDX North American Investment Grade Index, which tracks default swaps on 125 high-grade corporate bonds, reached a new milestone in the first half of 2018 of $1.56 trillion. That eclipsed every previous period in the past five years of data available.

Liquidity Grab

Investors are putting more allocations into more-liquid portfolio products so they can be more nimble in a downturn. When markets were rallying, people thought about liquidity, but it may not necessarily have been on the top of their agenda.

Heavy turnover in such derivatives typically coincides with periods of turmoil as investors rush to hedge credit risk

The migration to indexes at the expense of cash bonds and default swaps on individual credits has surged post-crisis as investors sought ways to weatherproof funds from liquidity risk. Now, volumes are rising as traders place bullish positions mindful of a looming reversal in the credit cycle. It’s been a reluctantly long environment for a while -- that is why these CDS overlays have been increasing.

Market Selloff Played Out in the Most Hidden Corners of Credit

According to Barclays data, investors bought $12.7 billion of on-the-run protection in CDX.IG between Feb. 2 and Feb. 9 -- a figure that dwarves the $2 billion worth of cash outflows from global investment-grade bond funds recorded by Bank of America Merrill Lynch for the week ending Feb. 14, 2018 -- the fifth-largest week of bond fund redemptions on record.

Some Sense

It makes some sense that investors reached for derivatives during the worst of the selloff, according to analysts at JPMorgan Chase & Co. Such instruments are more liquid than underlying bonds at a time when investors have long complained about their ability to buy and sell cash debt. But one factor that may be exacerbating the drama in derivatives is the amount of options written on them. So-called credit index options give traders the right to buy or sell CDS indexes and are said to have exploded in popularity in recent years as investors seek to juice their bets through leverage or to place broad bets on credit.

Liquidity becomes all-important when funds have to cash in their assets to meet redemptions. Today, heightened concerns about an escalating trade war and the prospect of tighter monetary policy are overshadowing the otherwise healthy economic backdrop for high-grade corporate credit.

Yield Curve Inversion

The inversion of the Treasury bond yield curve in 2000 and again in 2006 kicked off dramatic retreats in year-over-year percentage job increases. Eventually, job growth turned negative alongside economic recessions.

Since the 1960s, yield curve inversion has successfully foreshadowed all seven of the recessions that came to pass.

The yield curve’s flatness in 2018, as well as the prospect of yield curve inversion in 2018, is partially a function of longer-term bond yields falling.

It may not matter why the inversion of the yield curve tends to be bad for stock assets. Still, when it happens next, adding additional investment risk may be inopportune.

There has been a great deal of chatter about the strength of the American job market and support the notion that U.S. workers are "winning."

We now see a business cycle unemployment low. In fact, unemployment rate troughs tend to precede economic contractions and/or stock bears by about one year.

What's not necessarily talked about is the timing of precipitous slowdowns in job growth. For example, the inversion of the Treasury bond yield curve in 2000 and again in 2006 seemed to kick off dramatic retreats in year-over-year percentage job increases. Eventually, job growth turned negative alongside economic recessions.

Keep in mind, since the 1960s, yield curve inversion has successfully foreshadowed all seven of the recessions that came to pass. In other words, for whatever reason(s), when shorter-term interest rates have yielded more than longer-term interest rates, economic contraction has followed within a relatively short period of time.

What appears abundantly clear is that Fed Chairman Powell appears resolute on moving forward on a two-fold tightening path. He is going to continue raising overnight lending rates. And he is going to follow through on the reduction of balance sheet assets.

Theoretically, raising the overnight lending rate might not be as big a deal if longer-term debt maturities were rising in tandem. Yet, they haven't been. The 10-year yield has actually fallen 20 basis points since the Fed last raised its overnight target to a range of 1.75-2.00%. That has left a paltry difference between 10-year Treasury yields and two-year Treasury yields at 0.28%.

Chinese Corporate Credit Ratings

Dagong, the largest credit rating service in  Chins Slashed the US to BBB+, then was Suspended in China for Selling Fake AA and AAA Ratings to Chinese Outfits  (Aug 20, 2018) 

Maybe the US government refused to pay China’s Dagong Global Credit Rating for an AA or AAA rating?

Now, China struggles to contain its corporate bond morass.

At about the same time, Dagong gave Sunshine Kaidi New Energy Group, a privately-held Chinese company, an AA rating though there were already reports about the difficulties the company had with its debt. In June, the company defaulted on 18 billion yuan ($2.6 billion) in bonds. Since the default, Dagong slashed Kaidi New Energy’s rating four times to C.

Despite the government’s struggle to contain the growing corporate-debt meltdown in China, Dagong upgraded about a fifth of its clients’ credit ratings since the start of 2017, according to the  South China Morning Post.

It’s a broader problem: Dagong isn’t the only credit rating agency in China.

There is a whole industry, of which Dagong has about a 20% market share, though the three major US rating agencies – Standard & Poor’s, Moody’s, and Fitch – have been locked out of the market. Of the 1,744 Chinese companies that have issued bonds, 97% were rated AA or higher by Chinese rating agencies, with 27% (464 companies) being AAA-rated. In the US, only a handful of companies are still AAA-rated.

And, now two Chinese regulators have disclosed why rating agencies issue these AA and AAA ratings even as corporate debt meltdown becomes difficult to contain: Dagong had effectively sold high credit ratings to bond issuers.

Dagong released its own statement, apologizing for its actions.

No investor can trust anything Chinese companies – or Chinese rating agencies for that matter – disclose about their debts, and the only hope is the history of corporate bailouts by the Chinese government. But Chinese authorities are trying to wean investors ever so gradually off these assurances and have allowed a few bond defaults here and there to proceed to the great astonishment of befuddled investors.

Emerging Markets turmoil: The price of cheap debt & misallocation of capital. Read as Asia could become the next source of downside systemic risk for financial markets

As China Corporate Bond Defaults Balloon, the Debt Picture Becomes Complicated

As China continues to weigh how to approach rising corporate debt, new data reveals rising corporate bond defaults this year, according to Reuters on Thursday (Aug. 9, 2018).

Sixteen Chinese corporations, most of them private, have defaulted on 34 corporate bonds, reports said. The defaults are now worth $5.5 billion this year, a trend that adds tension to the complex issue of accelerating business borrowing. Reuters compared the 2018 data to last year’s, which saw 30 defaults worth $3.81 billion for the entirety of 2017.

Corporate bond defaults seem to be accelerating in China, with more than 40 percent of defaults this year occurring since early June. That rise is, in part, due to multiple missed payments from a single borrower. For instance, Wintime Energy Co., Ltd. missed four payments, reports said, while CEFC Shanghai International Group Ltd. has missed three since June.

The nation is struggling to balance easing credit requirements for corporate borrowers in an effort to jumpstart economic growth, and weighing the potential economic downside of rising debt, defaults and bad loans. Analysis by Fitch last June warned that efforts to curb corporate debt levels could have an adverse impact on the nation’s economy.

The China Banking Regulatory Commission (CBRC) described the nation’s corporate debt situation as “grim and complicated” in an issued January 2018 report, citing “the address of ballooning corporate debt as a top priority for the year”.

So, much for Global Corporate Debt Issuance

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