A key advisory committee to the US Treasury warned on Wednesday of the risks surrounding the “surge” in corporate borrowings and “potential spillovers”, as the Federal Reserve prepares to reduce the size of its $4.4tn balance sheet. In a letter to Secretary Steven Mnuchin, the Treasury Borrowing Advisory Committee said there was the possibility for a “meaningful, but not systemically risky, decline in both credit and equities” in an unfavourable market.
The committee — which is made up of large bond investors and primary dealers — said market ructions could affect the costs for the Treasury to borrow. “There was unanimous agreement that the traditional way of responding to cyclical debt needs by relying primarily on short-end funding would be inappropriate,” the committee wrote in its letter. “Given the potential magnitude of the funding gap going forward, the committee strongly recommends that the Treasury consider a broader increase in issuance across tenors” (ie longer term debt).
The market for corporate debt has ballooned to nearly $9tn from roughly $5tn before the financial crisis and is now three-fifths of the size of the outstanding Treasury market, according to data from Sifma, the industry trade group. Those borrowings have been propelled by the historic drop in yields (reduced interest on debt) as central banks in Europe, Asia and the US eased policies since the crisis began.
Measures of risk premiums on high-quality corporate debt have fallen towards the lowest level since the crisis at the same time as benchmark equity indices like the S&P 500 have touched record highs. In short, debt does not reflect true risk.
The Treasury will raise $62bn of securities across three-, 10-, and 30-year maturities in August, which will refund $47.3bn of privately held notes that mature later this month. Since mid-March when the debt ceiling was hit, the Treasury has employed what it characterises as “extraordinary measures” to help finance the government.
Source: Financial Times Eric Platt 3 August www.ft.com
Also, Supranational debt doubled
Nations have historically been the world’s best credits — but since the global financial crisis a decade ago they have been joined by a burgeoning group of supranational organisations. Syndicated debt issuance by supranationals has more than doubled in the past decade, hitting $265bn last year, according to figures from data provider Dealogic. These borrowers, such as the European Investment Bank, the EU and the International Bank for Reconstruction and Development, are backed by multiple countries and so enjoy the highest possible credit ratings.
Their ranks are set to increase further with the forthcoming entry into the capital markets of the Asian Infrastructure Investment Bank — dubbed by some as China’s answer to the World Bank — and the World Bank’s own planned expansion in fundraising through its subsidiary the International Development Association.
In Europe — one of the regions which has seen the highest volumes of supranational debt issuance in the past decade — a sizeable proportion of the increase has come from the eurozone’s bailout facilities, the EFSF and ESM, which can lend to troubled economies, such as Greece, at hundreds of basis points lower than they can access the markets themselves.
Supranationals also fill a financing gap left by banks as they retrench their activities. Tighter capital requirements that financial institutions now face mean they are obliged to hold larger volumes of highly rated debt instruments — but the number of sovereign borrowers enjoying the highest possible ratings has fallen, reducing the amount of government paper that is eligible for banks to buy.
The number of sovereign borrowers rated AAA by credit rating agency Standard & Poor’s has dropped from 20 to 12 in the past decade — just 9 per cent of all rated nations. At the other end of the scale the number of countries with junk credit ratings — BB and below — has risen from 49 to 62.
Before the financial crisis “it was mainly central banks” who bought supranationals’ debt, Mr Stirling said. “But now a wider range of investors focus on the asset class, most notably bank treasuries who are major buyers due to regulatory capital requirements . . . demand has increased dramatically from this investor group.” As a consequence, supranationals have evolved into a conduit to channel finance from banks to government infrastructure and trade schemes.
Supranationals’ lending agreements give them “preferred creditor” status, meaning that, if a borrowing nation gets into financial difficulty, they must be repaid before anyone else.
Source: Financial Times Kate Allen 9 August www.ft.com