Companies’ increasing reliance on non-bank credit is beginning to raise concerns about risks.
Worldwide corporate debt rose at a compound annual rate of 5.9% to $56 trillion in 2014, from $38 trillion in 2007, according to the McKinsey Global Institute’s report on global debt. Much of the $18 trillion companies have borrowed since 2007 has come from sources other than banks, mostly corporate bonds, but also simple securitisations and lending by insurers, pension and credit funds, leasing programmes, or peer-to-peer platforms.
In advanced economies, bank loans constituted 41% of outstanding corporate debt in 2014, down from 45% in 2007.
Banks reduced lending in the wake of the global financial crisis in 2008 and 2009 that exposed the risks of the long, complex chains of credit securitisation that proliferated before 2007. The non-bank credit that companies have taken on since then is less risky, according to the McKinsey report, because the financial instruments tend to be straightforward, simple, and generally transparent.
Some significant concentrations of today’s non-bank corporate debt, however, harbour potential risks.
Corporate bonds. Companies in the US, Europe, and emerging markets have issued record amounts of corporate bonds since 2008. Globally, the stock of outstanding corporate bonds increased to $11.3 trillion in 2014, from $7 trillion in 2007, according to the McKinsey debt report.
Authors of the report figure “there is more room for bond market development,” adding that even “when considering only companies with $500 million or more in revenue, we calculated that corporate bond issuance could increase by more than $1 trillion from current levels.”
But a survey of about 11,000 investment professionals in the UK suggested the risk a bond bubble is developing is increasing.
Seventy-six per cent of the respondents polled by the UK CFA Society in the first quarter of 2015 said they considered corporate bonds somewhat or very overvalued. That’s an 11-percentage-point increase over the past year and a record high since the CFA Society introduced the UK index three years ago.
“Quantitative easing has supported increases in asset values by depressing the rate at which future cash flows are discounted and by discouraging growth, thereby improving the outlook for earnings,” Will Goodhart, chief executive of CFA UK, said in a statement. “Our most recent survey results suggest that investment professionals feel that the prospects for additional benefits from QE may be limited.”
China’s real estate investments. Corporate debt in China has nearly quadrupled to $12.5 trillion since 2007, faster than borrowing by Chinese governments, households, or financial institutions, according to the McKinsey debt report.
Nearly half of the corporate debt in China is directly or indirectly related to real estate, including debt from property developers and lending to steel and cement industries. This poses a significant risk, according to the McKinsey debt report, because corrections of the Chinese real estate market, which saw property prices in 40 Chinese cities rise 60% since 2008, have begun.
A slowdown in the real estate market would be felt mostly in construction and related industries, which account for 15% of Chinese GDP. Thousands of small companies catering to the construction industry would have trouble keeping up with non-bank loans that they took out at high cost.
—Sabine Vollmer (svollmer@aicpa.org) is a CGMA Magazine senior editor.
