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Market Moves

Straw in Wind? Near-Junk Ratings Dominate US Corporate Bonds

Baa–rated issues reach record, although defaults at this stage are not worrisome, Moody’s data indicates.

By Larry Light

Corporate America has been indulging in a debt-issuing binge, thanks to ultra-low interest rates. The result is that a record share of corporate bonds now sits in the ratings tier just above junk status.

A record $2.96 trillion is rated Baa, the level right before high-yield, according to new data from Moody’s Capital Markets Research. That’s an unprecedented 48.5% of investment-grade bonds.

For now, this condition doesn’t appear ominous. The junk bond default rate at year-end 2018 was a mere 2.4%, down from 3.4% in 2017. Trouble is, once things go south, they can do so quickly.

In 2007, on the eve of the financial crisis, the default rate among speculative-grade bonds was about the same as now. The next year, however, it soared to 15%.

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At the moment, there hasn’t been much in the way of company ratings downgrades. But of the 22 investment-grade downgrades in last year’s fourth quarter, Moody’s figures show, 15 were from Baa.  The big reason for the surge in Baa credits isn’t downgrades, at this point. It’s that the bulk of newly issued bonds are rated Baa at the outset, because their companies have a lot of debt.

This expansion is partly due to an explosion of mergers and acquisitions. The big underlying reason for the debt feast, of course, has been the low rates, an era that is coming to an end with the Federal Reserve bent on jacking up short-term rates.

While long-term yields remain relatively low—2.75% for the benchmark 10-year Treasury, which is the major influence for corporate rates—that won’t stay static forever. Just last October, the 10-year T-note yielded 3.25%. (Global turmoil has since prompted investors, many of them foreign, to load up on the 10-year, pumping up its price and depressing its yield.)

The scary thing is that, in the estimation of Grant’s Interest Rate Observer, business debt as a percent of GDP tops 72%, which is more than the peak of the last economic up-cycle, 68.8% in 2017’s first quarter.

As financial pundit William D. Cohan recently wrote, vis-a-vis the corporate debt situation: “It’s been quite a party. Now comes the hangover.”

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Home > News > Risk > Swedish Pension Fund Divesting from Nukes, Oil Sands Companies
Risk

Swedish Pension Fund Divesting from Nukes, Oil Sands Companies

ESG-oriented decision motivated by new law.

By Chris Butera

Swedish pension provider AP4 is eliminating nuclear weapons and oil sands from its $40 billion portfolio following new legislation that took effect January 1.

“AP4 believes that the modernizations and upgrades of existing nuclear weapons systems that are now taking place are not in accordance with the spirit of the Non-Proliferation Treaty for Nuclear Weapons, which aims to abolish nuclear weapons in the long term,” the firm said in a release.

The organization’s decision to remove the oil sands stocks is aligned with the Paris Agreement’s aspirations for a low–carbon environment.

“Oil sand is a fossil energy source with high carbon dioxide emissions per energy unit and AP4 believes that this must be phased out in a global transition to a low-fossil society, in line with the UN Climate Convention and the Paris Agreement,” the fund said, adding that this move is a continuation of its climate reduction strategy. “Since then, AP4 has chosen to remove companies with the relatively largest emissions of greenhouse gases and fossil reserves through its low–carbon investments.” 

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AP4 also does not own any coal companies.

The laws allow Sweden’s four AP pension funds to make more illiquid and alternative investments than before.

In 2018, AP4 sold 45 nuclear weapons businesses and five oil sand companies, worth $332 million, according to IPE.com. Profits were reinvested into the global equity portfolio.

“We welcome the fact that sustainability is now introduced in the legislative text with the clarification that the administration should be exemplified through responsible investments and responsible ownership,” said Niklas Ekvall, AP4’s CEO. “In connection with the implementation of the new rules for sustainable management, we choose to further increase our ambitions and opt out of investments related to nuclear weapons and oil sands.”

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