Corporate bond markets haunted by elevated risks, OECD warns

A participant stands at the OECD headquarters in Paris during the presentation of the Economic Outlook at the 2013 OECD Week. (AFP pic)

PARIS: The cheap money policies that fueled the global economy’s rebound since the financial crisis may be about to turn sour.

The amount of corporate bonds in circulation has doubled over the last decade to US$13 trillion after companies binged on debt, causing “elevated risks and vulnerabilities,” the Organisation for Economic Cooperation and Development said in a report.

In the next three years, non-financial companies will have to pay back or refinance about US$4 trillion of corporate bonds, equivalent to the balance sheet of the Federal Reserve.

The danger is that the mountain of repayments coincides with a slowing global economy, changes in monetary policy as central banks attempt to normalise policy, and record levels of sovereign debt borrowing.

The combination of those factors could lead to a vicious circle.

“In the case of a downturn, highly leveraged companies would face difficulties in servicing their debt, which in turn, through lower investment and higher default rates may amplify the effects of a downturn,’’ the OECD said in a paper on corporate bond markets.

The Paris-based organisation isn’t just worried about the number of corporate bonds, it has also identified issues with quality.

That echoes a chorus of warnings from policymakers around the globe that risky companies with large debts could be vulnerable in a downturn.

Ratings for investment grade bonds have fallen to historical lows and the OECD’s own bond rating index – including non-investment grade bonds – has remained below BBB+ for nine consecutive years, the longest stretch since 1980.

Junk bonds

That situation raises the risk of a vast increase in non-investment grade bonds if a crisis sparks sudden downgrades.

The OECD estimates that if the rate of downgrading reached the level of 2009, the market for junk bonds would bloat by US$274 billion within a year, an amount that rises to US$500 billion if financial companies are included.

“The downgrade of a large amount of investment grade bonds may be hard to absorb by the non-investment grade market, causing volatility and spreads to rising,” the OECD said.

To cap it all, the risks come as risk appetite is already waning.

Global net issuance of corporate bonds fell to its lowest level in a decade last year. Net issuance of non-investment grade bonds turned negative.

“The only year that this has happened over the last two decades was in 2008,” the OECD said.