Credit: Riskier, rising investment-grade debt poses financial stability risk
admin | January 10, 2020
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
The rising share of ‘BAA’ bonds in investment-grade issuance and the diminished relevance of the ‘BAA-AAA spread’ as an economic indicator raise concerns about financial stability. ‘AAA’ and ‘BAA’ mark the top and bottom of credit categories of investment-grade bonds. The yield difference between the two rating categories captures the willingness of investors to take on corporate credit risk. During recessions or periods of market stress, the ‘BAA-AAA’ spread tends to widen, as investors shun excessive credit risk. However, changes in the underlying structure of the investment grade credit market over the past few years have reduced its usefulness as a risk measure, according to researchers at the Federal Reserve. The total offering amount of ‘BAA’ bonds has grown, at a faster pace since 2014, while that of ‘AAA’ bonds has remained low. Moreover, the increased ‘BAA’ issuance amount is dispersed across sectors, while ‘AAA’ corporate bonds are exclusive to two companies. There is also a duration mismatch, as the average maturity of ‘BAA’ paper has risen above 4 years in 2019, while the average maturity of the small amount of ‘AAA’ debt outstanding is below 1 year. The net leverage or ratio between a firm’s total debt (less cash and short-term investments) and EBITDA of investment-grade firms has meanwhile climbed even above that of high-yield companies. In light of rising and riskier investment-grade issuers, the possibility of rampant downgrades poses systemic risk. The Liberty Street Economics post is here. (Liberty Street Economics, APS)
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