Managing the Easy Money Environment
by Ron D’Vari, CEO and James Frischling, President, NewOak
Weekly market opinion from New Oak FinancialThe unprecedented and extended accommodative monetary environment, combined with ample liquidity, led to very low corporate default rates in 2013, with defaults expected to decline even further in 2014. The easy money environment has and will continue to allow distressed companies to access the capital markets and reduce refinancing risk in the near future. While not immediate, this creates serious concerns about credit fundamentals and a potential credit bubble aftershock in the medium and longer term.
With low global interest rates and corporate defaults, larger companies, as exemplified by Apple and Verizon, have been using their strong bond ratings and balance sheets to issue large amounts of longer-term debt. The primary purpose of new debt issuance has been to bolster planned stock buy-backs, cash dividends or to acquire other companies. The bigger global corporations have been optimizing their choices of maturity, currency and markets, and have been taking advantage of lower interest rates in Europe.
Two of the largest corporate bond issuances in history have taken place in the last 12 months: 1) $49 billion in bonds issued by Verizon last Fall to finance its acquisition of the remaining shares in Verizon Wireless it did not already own; and 2) Apple issued $17 billion in bonds 12 months ago, which was the world’s largest corporate debt sale at the time. Apple is expected to issue another $17 billion of bonds to boost its planned stock buy-back from $60 billion to $90 billion.
The fact that companies have relatively easy access to the debt capital markets is a positive factor for the credit markets for the short to intermediate term. However, how companies ultimately will use the cheap capital and leverage creates longer term concerns about the credit markets. If corporations use the opportunity to invest in capital equipment and expansion, the subsequent earnings growth will help support debt service coverage. This should be good for both equity and debt stakeholders. If the new debt is used only for stock buy-backs, that would make a sucker out of the bond holders. For now, the boost in stocks seems to reflect more the cheap and easy access to debt capital than a real expectation of top- and bottom-line growth, hence the concern for a credit bubble in making.
Mortgage Lending Plummets – Is It All About Rates?
In the first quarter of 2014, mortgage lending dropped to its lowest level in 14 years with the increase in interest rates touted as the reason for the decline. Rates have spiked in reaction to the Federal Reserve’s indication that it will be pulling back on its bond buying program and that the market has seen the last of these historically low levels.
While the average 30-year fixed rate mortgage has increased about 90 basis points since last May, the rate still remains well below its historical average. So is the bounce in interest rates the driver of the drop in mortgage lending? The answer is that rates explain part, but not the entire story.
The bigger driver of the fall in mortgage lending can be attributed to the combination of weak borrowers, tighter credit standards and a sharp rise in prices. The banks continue to be blamed for their role in the mortgage crisis, so conservatism on the part of most lenders continues to rule the day. Meanwhile, consumers are still recovering from the financial crisis and wage and job growth has been insufficient to dig them out of their holes. The incongruent environment of tighter credit standards by lenders and weakened borrowers doesn’t bode well for the housing market.
For the past few years, the euphoria around the housing market was fueled by the refinancing of existing mortgages, not new mortgages. The increase in interest rates put an end to the refinancing boom, but there was the expectation (or maybe the hope) that a second wave of buying would be powered by new borrowers.
The importance of housing on the broader economy shouldn’t be understated. For this market to advance further, lenders small and large will need their credit standards to ease. With so many banks looking to put money to work, this may yet prove to be a buyers’ market—with some patience.
