Fixed Income  

Rising risks in the bond market

The default rate is running below the long-run average, but an untimely end to the credit cycle or an rise in market stress could drive defaults. 

4. A debt wall is approaching

Between 2019 and 2022, $8.4tn (£6.42tn) of bonds will mature in global corporate debt markets, a record for this economic expansion. This is known as the “maturity wall”. 

Investors are concerned for two reasons: first, large maturity walls are challenging when interest rates are rising as companies are forced to refinance debt at higher rates at the expense of profitability; and second, the interest coverage ratio – the number of times a company’s earnings can cover its interest expenses – has fallen from 8.6x in 2012 to 7.3x in 2018, close to the lowest level since 2009.

Together, these suggest that spreads could widen if companies face increasing pressure to service their debt. 

The expansion-long hunt for yield has created demand for corporate bonds, helping to keep interest rates low. This should help ease the pressures of the approaching maturity wall.

Nonetheless, as maturing debt is rolled over, the focus should be on the quality of issuance and bonds that offer more protection for holders, even if that means sacrificing some additional yield.

5. Much of the debt has not been used for investment

In a perfect world, the money raised from issuing debt would be allocated to inward investment, including research and development and boosting productivity as a means to grow profits.

Over the course of this cycle, debt not used for refinancing has been put toward mergers and acquisitions activity, share buybacks and dividends. 

In the US market, data on the use of bond proceeds is minimal, other than to specify whether or not funds are allocated to M&A activity. Since 2015, 29 per cent of non-financial US corporate debt issuance has been for M&A purposes.

In contrast, the data for leveraged loans and US high-yield bond issuers is more robust. Since 2010, 60 per cent of issuance has been dedicated to refinancing existing loans, with a further 27 per cent being dedicated to M&A activity.

Overall, only about 8 per cent of issuance has been focused on ‘general corporate’ activities, which includes business spending and investment. 

Investment implications

As investors have been starved of income throughout this expansion, the corporate world has responded by issuing an increasing amount of debt of lower quality. 

The structural changes to global debt markets may not present an immediate threat to portfolios. However, with renewed fears about the end of the credit cycle, the risks of what this may mean for markets is becoming prominent. 

Part of having a resilient portfolio is understanding what you own and the risks.

Alex Dryden is global market strategist at JPMorgan Asset Management