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esting in europe closely followed the actions of the european central bank in particular the quantitative easing implemented in response to the european debt crisis in june 2016 the ecb began using its corporate sector purchase programme cspp acquiring 10 4 billion euro in non financial corporate bonds in the first month of operation with the explicit purpose of ensuring liquidity in the corporate bond market 20 news in mid 2019 that the ecb would restart its asset purchase program pushed the iboxx euro corporate bond index valued at 1 92 trillion to record highs 21 the increased purchases resulted in 42 of european investment grade corporate debt having a negative yield as investors effectively paid less risky companies to borrow money 22 the federal reserve bank of new york noted in january 2020 that only two u s firms had the highest rating of aaa johnson johnson and microsoft while there was an increased number of firms at the lowest end called baa on the moody s rating scale or bbb on the s p rating scale investment grade firms those with a rating between aaa and baa were more highly leveraged than the high yield junk firms observing that investors tend to divest bonds that are downgraded to high yield the new york fed stated in the current corporate debt landscape with a greater amount outstanding of baa rated corporate debt and higher net leverage of investment grade debt overall the possibility of a large volume of corporate bond downgrades poses a financial stability concern 23 examples of leveraged corporate debt transactions include halliburton doubled its corporate debt to 11 5 billion between 2012 and 2020 it sold 1 billion in debt in early march 2020 with the explicit purpose of paying off existing debt and has 3 8 billion in debt payments due through 2026 18 at t debt ballooned to 180 billion following its acquisition of time warner in 2016 in 2018 moody s declared at t to be beholden to the health of the capital markets because of its reliance on continued credit to service its debt load 12 kkr sold about 1 3 billion of cov lite debt in 2017 to pay for its buyout of unilever despite moody s rating the offer 4 99 on a scale of 1 to 5 with 5 being the riskiest 12 kraft heinz had its credit rating downgraded to bbb or junk in february 2020 due to low earnings expectations and the firm s determination to use available capital to provide stock dividends rather than pay down debt 24 that month kraft heinz had 22 9 billion in total debt with only 2 3 billion in cash assets 25 the s p 500 cyclically adjusted price to earnings ratio cape suggest that the index reached an overvaluation in the late 2010s not seen since the collapse of the dot com bubble corporations in the united states have used the debt to finance share buybacks dividends and mergers acquisitions that boost share price to a greater extent than before this has been done in place of long term business investments and expansions 16 the u s tax cuts and jobs act of december 2017 offered a tax holiday under the logic that firms would use the extra profits to increase investments instead it vastly increased an existing trend towards share buybacks which increase the value of the remaining publicly traded shares and contributed to the rise of stock market indexes generally 26 while the s p 500 has risen by over 300 from its low in the great recession this rise is driven partly by the selling of corporate debt to purchase stock that becomes more expensive due to the purchases the cyclically adjusted price to earnings ratio for the s p 500 indicates it is the most overvalued it has been since the dot com bubble and is around wall street crash of 1929 valuations 16 the mckinsey global institute cautioned in 2018 against excessive alarm noting that if interest rates rose by 2 less than 10 of bonds issued in all advanced economies would be at higher risk of default with the percentage falling to less than 5 of european debt which is largely issued by aaa rated companies 5 search for yield results in growth in covenant light bonds edit main article cov lite most leveraged corporate bonds are cov lite or covenant light that do not contain the usual protections for purchasers of the debt in some cases cov lite terms may force the purchaser of the debt to buy more debt 27 by mid 2018 77 4 of u s leveraged corporate loans were cov lite 28 cov lite loans as a percentage of outstanding leveraged loans in european markets reached 78 in 2018 compared to under 10 in 2013 29 investors seeking stronger covenants lost the struggle with companies and private equity firms seeking to offload risk to the buyers of their debt a writer for bloomberg news opined in february 2020 if and when the credit cycle turns the aggressive push toward weakening protections virtually ensures that recovery rates will be worse than in 2008 but there s no going back now the risky debt markets are full of cov lite deals investors either have to acclimate to that reality or get out of high yield and leveraged loans 30 chinese debt edit the chinese government s reaction to the 2008 financial crisis was to direct banks to loan to chinese state owned enterprises soes which then built factories and equipment to stimulate the economy despite the lack of demand for the products created the economic activity of soes in 2017 was 22 of china s total gdp though soes accounted for over half of china s corporate debt it is often not clear the degree to which chinese soes are owned by the state making it difficult to differentiate corporate and sovereign debt government directed lending gradually shifted from large banks offering loans to smaller local and provincial banks offering lightly regulated wealth management products this shadow banking sector grew from 80 billion in 2006 to almost 9 trillion in 2018 31 vice premier liu he is the chair of the chinese financial stability and development committee in 2017 the international monetary fund estimated that 15 5 of all commercial bank loans in china were made to firms that did not have an operational cash flow sufficient to cover the interest on the loans a 60 default rate of these loans could result in losses equal to 7 of chinese gdp in 2017 both moody s and standard poor s financial services llc downgraded china s sovereign debt rating because of concerns about the health of the financial system 31 the chinese government recognized the risk posed by corporate debt the 13th five year plan unveiled in 2015 included financial reforms to reduce capacity in highly leveraged sectors there were a wide variety of other policies and restrictions implemented to reduce debt burdens and manage the failure of zombie firms in 2017 the government established the financial stability and development committee chaired by vice premier liu he to coordinate financial regulation with the full impact of new regulations expected in 2021 31 the china united states trade war that began in 2018 forced the government to pause debt reduction efforts in order to emphasize stimulus as both domestic and global demand for chinese products fell 8 government attempts to crack down on risky debt combined with the economic slowdown to quadruple the size of defaults on yuan denominated bonds from 2017 to 2018 32 the government subsequently encouraged banks to increase lending in particular to small struggling firms in the first half of 2019 local governments issued 316 5 billion in bonds 33 in december 2019 both moody s analytics and fitch warned that chinese debt was the biggest threat within the fault line in the financial system and the broader economy posed by overall corporate debt 8 fitch noted that 4 9 of chinese private companies had defaulted on bond payments in first 11 months of 2019 compared to 0 6 in all of 2014 19 potential role of corporate debt in a future recession edit the amount of us corporate bonds held by mutual funds tripled in the decade following the 2008 financial crisis the organisation for economic co operation and development noted in february 2020 that today s stock of outstanding corporate bonds has lower overall credit quality higher payback requirements longer maturities and inferior covenant protection that may amplify the negative effects that an economic downturn would have on the non financial corporate sector and the overall economy 34 if the corporate debt bubble bursts the bonds would be repriced resulting in a massive loss by the mutual funds high yield funds pension funds and endowments with corporate bond assets as with the 2008 crisis this may result in increased caution by lenders and the shrinking of the entire bond market resulting in higher rates for individual consumers for mortgages car loans and small business loans 12 the international monetary fund conducted a stress test for a hypothetical shock half as large as the 2008 crisis and found that 19 trillion of corporate debt from eight countries china the united states japan the united kingdom france spain italy and germany representing roughly 40 of all corporate debt would be at risk of default because it would be difficult for companies to raise cash to repay loans that come due 35 in contrast other observers believed that a crisis could be averted noting that banks are better capitalized and central banks more responsive than in the 2008 financial crisis in 2019 the mckinsey global institute expressed doubt that defaults in the corporate debt market would result in systemic collapses like that caused by the subprime mortgage crisis 5 on 12 march 2020 kenneth rogoff of harvard university stated i don t think we have anything shaping up like 2008 or 1929 particularly in the united states 4 though he later revised as the situation worsened stating on 30 march there is a good chance it will look as bad as anything over the last century and half 36 concern about covid 19 related economic turmoil edit further information covid 19 recession and financial impact of the covid 19 pandemic social distancing and other responses to the covid 19 pandemic caused drops in economic activity and corporate revenues pictured new york city s theater district largely deserted on a saturday night in march 2020 several financial commentators expressed alarm at the economic fallout of the covid 19 pandemic and related collapse of the agreement between opec and non opec producers particularly russia to prop up crude oil prices and resulting stock market crash during the week of 9 march 2020 the concern is that this economic instability may initiate the collapse of the corporate debt bubble 18 37 38 39 the total economic debt owed by non financial companies in early march was 13 trillion worldwide of which about 9 6 trillion was in the u s 4 the chief investment officer of guggenheim partners noted on 9 march 2020 the overleveraged corporate sector is about to face the prospect that new issue bond markets may seize up as they did last week and that even seemingly sound companies will find credit expensive or difficult to obtain our estimate is that there is potentially as much as a trillion dollars of high grade bonds heading to junk that supply would swamp the high yield market as it would double the size of the below investment grade bond market that alone would widen yield spreads even without the effect of increasing defaults 40 at end of the trading day on 9 march the yield spread for junk bonds reached 6 68 from a low of 3 49 on 6 january as sellers attempted to lure cautious traders with higher yields the bonds of firms in the energy sector who make up about 10 of the total junk bond market and were particularly exposed to the saudi russian oil price war suffered large yield spreads 41 42 43 a debt default by energy companies would harm the regional banks of texas and oklahoma potentially causing a chain reaction through the corporate bond market 44 on 12 march the spread on junk bonds over u s treasuries increased to 7 42 in u s markets the highest level since december 2015 indicating less willingness to buy corporate debt as the airline and oil industries faced dire consequences from the economic slowdown and the russia saudi arabia oil price war investors became increasingly concerned that corporate bond fund managers dealing with redemption requests from clients would be forced to engage in forced liquidation potentially prompting other investors to try to sell first driving down the value of the bonds and increasing the cash crunch on investors 45 a concern is that companies unable to cover their debt will draw down their credit lines to banks thereby reducing bank liquidity 46 an example is boeing which declared on 11 march that it would draw down the entirety of a 13 825 billion line of credit meant to cover costs related to the boeing 737 max groundings to preserve cash resulting in an 18 drop in its stock 47 48 while u s banks should have capacity to supply liquidity to companies due to post 2008 crisis regulations analysts are concerned about funds holding bonds which were also seeking to build cash reserves in anticipation of imminent client withdrawals during the economic turmoil 46 in the week of 9 march investors pulled a record 15 9 billion from investment grade bond funds and 11 2 billion from high yield bond funds the second highest on record 45 as of 13 march the market was pricing in about a 50 chance of recession indicating future strain if a recession actually came to pass 46 european central bank president christine lagarde oversaw the creation of a pandemic emergency purchase programme on 19 march from 20 february to 16 march 2020 the yield of the iboxx euro liquid high yield index doubled the market for new european junk rated corporate debt including leveraged debt had effectively disappeared around 38 billion euros of debt is due by junk rated corporate and financial issuers in european currencies by the end of 2021 analysts were concerned that eurozone companies vulnerable to the covid 19 economic downturn and with debt coming due over the next two years would be unable to refinance their debt and would be forced to restructure 49 one u s analyst on 16 march opined the longer the pandemic lasts the greater the risk that the sharp downturn morphs into a financial crisis with zombie companies starting a chain of defaults just like subprime mortgages did in 2008 50 on 19 march the european central bank announced a 750 billion euro 820 billion bond buying program called the pandemic emergency purchase programme to calm european debt markets 51 52 the pepp and corporate sector purchase programme were authorized to buy non financial commercial paper 53 fed action soothe u s markets at the end of march edit in the week of 23 march investment grade firms in the us issued 73 billion in debt about 21 higher than the previous record set in 2013 these firms sought to build cash reserves prior to the full impact of the recession for example the 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