Capital Markets Monitor Key Issues

Transcription

1 Capital Markets Monitor Key Issues JUNE 215 Over the past few years there has been growing concern that leverage or risk-taking in general has been migrating from banks to non-banks, including institutional investors and non-financial corporations, both in mature and emerging economies. Against a backdrop of bank deleveraging and de-risking, years of ultra-low rates, and in many cases government efforts to develop corporate bond markets there has been a notable shift in the funding mix of the global corporate sector towards bond financing. While broad-brush indicators including debt/equity ratios flattered by the stock market rally in recent years suggest little reason for concern, corporate leverage has been on the rise in a number of areas including the high-yield and EM corporate sectors. Rising leverage is also apparent in the rapid growth of retail investors use of margin debt in equity investment. This edition of Key Issues continues our new publication format for the IIF Capital Markets Monitor (CMM). CMM Key Issues will be published during the first week of each month, followed by a CMM Chartbook during the second week. CMM Special Features will be issued as CMM Research Notes over the course of the month. We invite you to visit our CMM web page, where Key Issues and other CMM features will be posted as soon as they are available. If you would like to receive notifications about the latest CMM Reports, when they are released, please subscribe here. The Capital Markets Monitor and other IIF publications are available on the Institute s website: Questions or comments regarding this publication may be addressed to: Hung Tran Executive Managing Director htran@iif.com Sonja Gibbs Director, CEM sgibbs@iif.com Zeynep Elif Aksoy Senior Financial Economist zaksoy@iif.com Emre Tiftik Financial Economist etiftik@iif.com Fiona Nguyen Senior Research Analyst fnguyen@iif.com 1 Non-Financial Corporate Sector: Share of Bond Market Funding percent Latam EM Asia EM Japan EM Europe Source: Fed, ECB, BoJ, BIS, national sources, IIF. Data cutoff date: May 29, 215 iif.com Copyright 215. The Institute of International Finance, Inc. All rights reserved.

2 CAPITAL MARKETS MONITOR June 215 page 2 One of the key vulnerabilities exacerbating the 28-9 financial crisis was high levels of leverage in many banking systems (Chart 2). Consequently, an important component of global financial regulatory reform has been to reduce leverage in banks, through measures such as capital requirements and leverage ratios. However, over the past few years there has been growing concern that leverage or risktaking in general has been migrating from banks to nonbanks, including institutional investors and non-financial corporations, both in mature and emerging economies. This edition of CMM Key Issues assesses recent developments in specific measures of leverage in different sectors of the global economy in the context of an overall increase in the debt/gdp ratio of the global economy, driven by growth in public sector debt in mature economies and private sector debt in EM countries. Due in part to data limitations, small sample sizes and comparability of sources, the results obtained below are preliminary. They show mixed developments, with deleveraging in some corporate sectors but increasing leverage in others, mainly high-yield and some EM corporate sectors, as well as retail investors relying on margin loans to invest in equities. DECLINING LEVERAGE IN BANKS As a result of regulatory changes, market pressure and changes in bank business strategies, bank deleveraging has been pronounced in the post-crisis period: using a simple measure of total banking sector assets as a multiple of total equity, bank leverage has fallen from 15.5x in Q38 to just over 9x at present, and from over 24x in the to under 18x over the same period (Chart 3). As a result of declining leverage and profit margins reflecting slower economic recovery and relatively higher levels of NPLs in the banks there have seen their ROEs falling toward 5%. This is comparable to the ROE level of Japanese banks, which by contrast have improved their return performance from negative levels in Persistently low ROE in many banks remains a challenge for them in raising fresh equity to strengthen their balance sheets, so as to be in a position to extend credit to support the economy. More broadly, against a backdrop of bank deleveraging and de-risking, years of ultra-low rates, and in many cases government efforts to develop corporate bond markets there has been a notable shift in the funding mix of the global corporate sector towards bond financing (Chart 1, page 1). While bank loans still represent the majority of corporate funding outside the, the share of bond market financing has been increasing significantly. With plans for an EU Capi- 2 Source: Bank of Canada, Bloomberg, financial statements Source: Bloomberg, MSCI, IIF. 4 Pre-Crisis: Banking Sector Leverage assets as a multiple of capital UK and : Post-Crisis Deleveraging Total assets to total equity, times S&P5: Earnings, Dividends and Buybacks $ billions 3 Reported earnings 25 Buybacks Dividends Source: S&P, Bloomberg, IIF iif.com Copyright 215. The Institute of International Finance, Inc. All rights reserved.

3 CAPITAL MARKETS MONITOR June 215 page 3 tal Markets Union under discussion, and ongoing development of domestic institutional investor bases in many emerging markets, this trend is likely to persist if not accelerate. LEVERAGE IN THE NON FINANCIAL CORPORATE SECTOR As background, since the financial crisis, large corporations notably those that make up the S&P5 have used most of their earnings to give cash back to shareholders via dividends and stock buybacks (Chart 4). In fact, since 29 the cumulative volume of stock buybacks by S&P5 corporations has reached over $2.3 trillion. This behavior seems to have been prompted by the assessment by both corporate management and investors that there have not been enough promising investment opportunities for companies to invest in. Consequently, returning cash to stockholders has been significantly rewarded by investors indeed, S&P5 firms making substantial cash buybacks have enjoyed a remarkable share price outperformance over the S&P benchmark. In addition, major corporations have also accumulated record amounts of cash estimated to be close to $3.6 trillion while following a subdued capex strategy. While engaging in stock buybacks, companies have also issued a record volume of bonds to take advantage of ultra-low interest rates and to extend maturities a fresh high of $3.2 trillion in 214, with an even faster pace in the first 5 months of 215. As a consequence, mature market non-financial corporate debt as a percentage of GDP is only slightly above pre-crisis levels, while non-financial corporate debt in emerging markets has risen much more sharply (Chart 5). Greater deployment of debt has been reflected across a number of closely watched indicators of corporate leverage, including gross leverage (defined for this purpose as total debt to EBITDA). For example, while gross leverage in the nonfinancial investment grade corporate sector remains at moderate levels below 3x, it has risen steadily since 211, and is now at its highest level since 22. Some specific sectors of the S&P5 index, including telecommunications and healthcare, have seen a sharper runup in gross leverage (Chart 6). However, indicators including net leverage and debt to equity ratios show a different side of the story. Thanks to the accumulation of record amounts of cash and earnings, net leverage ratios (net debt/ebitda) for the broad market (including financials) have fallen markedly since 29. The same is true for the and Japan, though BRIC firms are showing slightly more leverage on this measure (Chart 7). Similarly, total leverage in terms of total debt to total equity of S&P5 companies has also fallen sharply, from a long-term average of 16% to around 1% at present (Chart 8), thanks to the substantial equity market rally in recent years. A more 5 Source: BIS, IMF, IIF 6 Source: S&P, Bloomberg, IIF. 7 Non-Financial Corporate Indebtedness percent of GDP, weighted averages Net Leverage Ratio Net debt to EBITDA, MSCI indices 12 1 Japan 8 BRIC Mature markets Emerging markets Gross Leverage Ratio - Selected S&P Sectors total debt to EBITDA 3. Telecom Healthcare Consumer staples Energy Source: Bloomberg, J.P. Morgan, IIF. iif.com Copyright 215. The Institute of International Finance, Inc. All rights reserved.

4 CAPITAL MARKETS MONITOR June 215 page 4 moderate decline in total corporate leverage has also been observed for large firms in other mature economies, except for the UK where leverage has declined only more recently after a sharp increase through 212. LEVERAGE IN THE HIGH-YIELD SECTOR In contrast, high-yield companies have also issued record amounts of bonds, but have shown more subdued earnings growth. Consequently, leverage ratios (measured as debt/ EBITDA) of global high-yield firms across the,, UK and Japan have risen markedly (Chart 9), exposing some borrowers in this sector to potential debt-servicing and roll-over difficulties as interest rates are normalized. LEVERAGE IN THE EM CORPORATE SECTOR EM corporations have increased their international and local currency bond issuance significantly, and in recent quarters have also stepped up their bank borrowing. As a result the overall indebtedness of the corporate sector relative to the GDP of EM countries has risen visibly, from around 6% in 28 to more than 8% at present (see Chart 5 and our new CMM Research Note, Corporate Debt in Emerging Markets: Where are the Risks? ). While direct comparisons across countries are challenging due to different reporting standards and data availability, leverage in the EM corporate sector (including financial corporates) in terms of debt to earnings (EBITDA) ratios has climbed to a record of over 4 times, due to stepped-up borrowing in recent years but also due to the relative weakness in EM corporate earnings (Chart 1). For emerging markets, overall debt-to-equity ratios tell a similar story total debt/equity for the broad equity market index has risen from 6% in 25 to over 1% at present. However, the bottom-up picture is more nuanced: using a small sample of top EM non-financial corporations, many countries show stable or moderately rising leverage. Notable exceptions include Mexico (where the telecommunications sector in has seen strong growth in corporate borrowing in recent years), Russia, China and to a lesser extent Turkey (Chart 11). LEVERAGED LOANS AND LEVERAGED BUYOUTS Issuance of leveraged loans increased significantly to a record levels of $1.6 trillion in 213, prompting banking regulators to issue a guidance letter to caution banks against relaxing credit standards. Issuance has subsequently slowed, but remains at historically high levels. What is also noteworthy is the visible decline in the market share of the top 7 bank underwriters from 8% in 28 to around 4% now (Chart 12). With top banks under closer regulatory scrutiny, smaller banks and non-banks have gained market share. Another example is in the home loan market, where non-banks have doubled their share of government-backed mortgage originations over the past year, to 53% in April 215. iif.com Copyright 215. The Institute of International Finance, Inc. All rights reserved S&P 5: Total Leverage Ratio total debt to total equity ratio; dotted line = period average Source: Bloomberg, J.P. Morgan, IIF. G4 HG & HY Non-Financial Corporates: Debt-to-Equity Ratio ratio High-yield High-grade Source: Bloomberg, company financials, IIF. Includes top 5 firms by market capitalization in each sector. Emerging Market Corporate Sector Leverage debt to EBITDA, times Gross Net Source: Bloomberg, MSCI, IIF. Includes financial corporates.

5 CAPITAL MARKETS MONITOR June 215 page 5 Also as a result of regulatory guidelines, leverage in terms of debt/ebitda has come down to 5.9x for announced large LBOs, less than the cap of 6x. Leverage rose to a recent peak of 6.96x in Q By contrast, some European LBOs have seen leverage (debt/ebitda) rising to 1x, exceeding the levels seen before the 28-9 financial crisis. USE OF MARGIN DEBT BY RETAIL INVESTORS retail investors increased their use of margin debt to nearly $5 billion in early 215 well in excess of the levels seen at the top of the dot com bubble in 2 ($4 billion), and just ahead of the 28 crisis (nearly $45 billion). Chinese retail investors have also increased their equity investment via margin borrowing by 84% this year to more than RMB2 trillion ($394 billion) a record level (Chart 13). A wave of recent IPOs and equity issuance by stockbrokers in Hong Kong has been planned to fund even more margin loans. Apparent reliance on high and rising margin loans is a source of vulnerability to the currently high-flying Chinese equity markets which have risen by over 2% over the past year. One example of this fragility was the sharp 6.5% correction on May 28, as more Chinese brokers announced steps to tighten requirements to slow down the growth in margin loans. LEVERAGE EMBEDDED IN FINANCIAL PRODUCTS Given prevailing low interest rates, investment products designed to enhance yield or higher return by using derivatives, (hence embedded leverage), have gained in popularity. However there has not been much comprehensive and timely data to gauge the growth of these financial products that contain embedded leverage. During a large market correction, such products could well post sharper-than-anticipated losses, particularly for less-sophisticated retail investors. Concretely, in the case of closed-end mutual funds, over 7% of them employ more than 5% effective leverage. The percentage of mutual funds increasing their use of financial leverage has also been rising of late, per a recent Fed dealer survey. However, there has been little growth in AUM of synthetic ETFs in recent years, especially for equities overall AUM is still low relative to the ETF universe more broadly. 11 Source: Bloomberg, company financials, IIF. Includes top 5 non-financial corporate firms by market capitalization in each country. Mexico is skewed by telecommunications giant America Movil, with over 28x D/E EM-1: Non-Financial Corporates: Debt-to-Equity Ratio ratio MX TR RU ZA SA BR CN PL ID IN Source: Thomson ONE, IIF Leveraged Loan Issuance and the Top Underwriters $ billion % share of Top 7 underwriters 14 Issuance China: Margin Lending and Newly Opened Margin Accounts CNY trillion thousands 2. Top 7 underwriters (rhs) Newly opened margin accounts (rhs) Margin lending In conclusion, the ongoing shift in leverage away from the banking sector has resulted in greater financial risk-taking, at least in some non-bank sectors. The speed, scale and ripple effects of this shift which is transforming the financial services industry should be closely monitored and better understood Source: Haver Analytics, IIF iif.com Copyright 215. The Institute of International Finance, Inc. All rights reserved.