After every crash there will always be a handful of experts pointing out that they had seen it all coming years before.
Fears have been raised that less than
five years on from the bankruptcy of Lehman Brothers the world is
setting itself up for another crash Photo: Getty Images
When dotcoms crashed, sub-prime imploded and banks collapsed it was not hard
to find the markets’ Cassandras who had spotted the problem and either made
millions betting against the bubble or written a book explaining how it was
all going to go wrong.
Today, another bubble is ballooning but unlike those that have gone before it
most investors, policymakers and analysts are well aware of its existence
and the problems it could create.
Sales of high-yield debt – or, as they were once known, junk bonds – have
exploded this year. In January alone, non-investment grade Asian companies,
those whose debt is ranked by credit rating agencies as riskiest, sold just
over $9bn (£6bn) of high-yield bonds, a year-on-year increase of more
6,000pc, according to figures from data provider Dealogic. In Europe, sales
of high-yield debt is also running at record levels and nearly $30bn of
bonds have been sold so far this year.
The massive increase so soon after a financial crisis that was caused in part
by the credit meltdown has raised fears that less than five years on from
the bankruptcy of Lehman Brothers and the near failure of Royal Bank of
Scotland and HBOS, the world is setting itself up for another crash.
In large part, the explosion in demand for high-yield debt has been a direct
consequence of the response of Western governments to the last crisis. Since
Lehman’s collapse, some $12 trillion has been pumped into the global
financial system by central banks across the world in an effort to prop up
banks and maintain low interest rates.
The impact of this unprecedented monetary stimulus has been to create a potent
mix of historically low yields on government bonds and rising inflation,
forcing even the most conservative of investors to hunt for yield in an
effort to preserve their capital and achieve a return.
“What you’ve basically seen is people who don’t really want to take more risk being forced up the risk curve to get the yield they need,” says one London-based bond trader.
This phenomenon explains the seemingly contradictory findings of research by S&P Capital IQ, the research arm of the ratings agency Standard & Poor’s, which put out a report earlier this month titled “High yield corporate bonds: still a risk worth taking?”.
S&P noted with alarm that despite its risk models showing that the probability of high-yield companies defaulting had nearly doubled in the past 12 months to a one-in-three chance, the yield on the bonds had halved over the same period as money continued to flood in.
“Despite the UK heading for another possible recession and many European economies still struggling, demand for European high-yield corporate bonds is soaring,” said S&P analyst Claudia Holm.
Into this worrying mix has also come signs of investor leverage as some wealthy individuals and funds borrow money to supercharge the returns they can make on their holdings of high-yield bonds.
Several bankers and investors said the provision of leverage was now common in Asia, where clients of private banks will routinely demand to be lent money to win their custom amid a dog-fight among local and international banks to win a share of the region’s increasingly wealthy private investor base. Experienced traders regard many of these newcomers as “dumb money” and point to the enthusiasm with which the clientele of Asian private banks have bought highly-risky bail-in bonds from European banks.
The most notorious case of this was the sale by Barclays in November of a 10-year $3bn CoCo, or contingent convertible bond, which attracted enough orders to sell the debt more than five times over. That was despite the inclusion of a clause that meant that should the bank’s capital levels fall below a predetermined level the entirety of the investment would be wiped out.
Christine Johnson, manager of Old Mutual’s corporate bond fund, was among those alarmed at the terms on which Barclays was able to sell its CoCo.
“By losing all value prior to existing credit and equity investors, this bond is essentially providing insurance to every other investor. In short, investing in these bonds is like being in a reverse lottery where someone gives you one pound every week and then suddenly turns up demanding millions,” said Ms Johnson.
In Barclays’ case, a substantial portion of the demand appeared to have come from Asian private banks whose customers were attracted by the prospect of owning bonds in a British bank that pay a 7.625pc coupon. “The Asians will buy anything that carries an 8pc coupon because they think it’s lucky,” says one senior portfolio manager. “You’ve got to understand there’s far more of a gambling mentality out there – it’s an entirely different mindset.”
Imprudent investing by wealthy Asians will not be something to overly worry European authorities, particularly if they are helping fill the capital holes in the banking system. However, the concern is that much of the money being pumped into high-yield debt is not only from speculators, but supposedly conservative institutions like pension funds and large insurers. The chief executive of one insurer admits privately to the problems faced in finding places to invest. “It’s a real problem. We have fixed liabilities and we have to get a certain return in order to meet them. A few years ago you could get the yield you needed from a triple-B issuer, but today to get the same return you are looking at double-B or lower,” he said.
And for final evidence of the high-yield bubble look at the hiring market for bankers. Last week, RBS poached UBS’s former head of US high-yield bond sales, only a month after announcing plans to scale back its investment banking arm. Like other major banks, RBS is making millions from the sale of risky bonds to investors. It doesn’t take an expert to know how that ended last time around.
“What you’ve basically seen is people who don’t really want to take more risk being forced up the risk curve to get the yield they need,” says one London-based bond trader.
This phenomenon explains the seemingly contradictory findings of research by S&P Capital IQ, the research arm of the ratings agency Standard & Poor’s, which put out a report earlier this month titled “High yield corporate bonds: still a risk worth taking?”.
S&P noted with alarm that despite its risk models showing that the probability of high-yield companies defaulting had nearly doubled in the past 12 months to a one-in-three chance, the yield on the bonds had halved over the same period as money continued to flood in.
“Despite the UK heading for another possible recession and many European economies still struggling, demand for European high-yield corporate bonds is soaring,” said S&P analyst Claudia Holm.
Into this worrying mix has also come signs of investor leverage as some wealthy individuals and funds borrow money to supercharge the returns they can make on their holdings of high-yield bonds.
Several bankers and investors said the provision of leverage was now common in Asia, where clients of private banks will routinely demand to be lent money to win their custom amid a dog-fight among local and international banks to win a share of the region’s increasingly wealthy private investor base. Experienced traders regard many of these newcomers as “dumb money” and point to the enthusiasm with which the clientele of Asian private banks have bought highly-risky bail-in bonds from European banks.
The most notorious case of this was the sale by Barclays in November of a 10-year $3bn CoCo, or contingent convertible bond, which attracted enough orders to sell the debt more than five times over. That was despite the inclusion of a clause that meant that should the bank’s capital levels fall below a predetermined level the entirety of the investment would be wiped out.
Christine Johnson, manager of Old Mutual’s corporate bond fund, was among those alarmed at the terms on which Barclays was able to sell its CoCo.
“By losing all value prior to existing credit and equity investors, this bond is essentially providing insurance to every other investor. In short, investing in these bonds is like being in a reverse lottery where someone gives you one pound every week and then suddenly turns up demanding millions,” said Ms Johnson.
In Barclays’ case, a substantial portion of the demand appeared to have come from Asian private banks whose customers were attracted by the prospect of owning bonds in a British bank that pay a 7.625pc coupon. “The Asians will buy anything that carries an 8pc coupon because they think it’s lucky,” says one senior portfolio manager. “You’ve got to understand there’s far more of a gambling mentality out there – it’s an entirely different mindset.”
Imprudent investing by wealthy Asians will not be something to overly worry European authorities, particularly if they are helping fill the capital holes in the banking system. However, the concern is that much of the money being pumped into high-yield debt is not only from speculators, but supposedly conservative institutions like pension funds and large insurers. The chief executive of one insurer admits privately to the problems faced in finding places to invest. “It’s a real problem. We have fixed liabilities and we have to get a certain return in order to meet them. A few years ago you could get the yield you needed from a triple-B issuer, but today to get the same return you are looking at double-B or lower,” he said.
And for final evidence of the high-yield bubble look at the hiring market for bankers. Last week, RBS poached UBS’s former head of US high-yield bond sales, only a month after announcing plans to scale back its investment banking arm. Like other major banks, RBS is making millions from the sale of risky bonds to investors. It doesn’t take an expert to know how that ended last time around.
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