According to ICE Data Services, global corporate bond issuance hit a record $2.6 trillion last year, beating the previous (2017) record. Nordic issuance, still a small share of the global market, amounted to some $25 billion. About half was in high-yield corporate bonds, marking another record year in that segment.
On the demand side, we've done our small part through strong inflows in our Nordic fixed-income funds. On the supply side, much has been said about banks offloading loans due to stricter capital requirements. A forthcoming Journal of Finance article suggests, however, that favourable pricing of risk in the bond market may also be part of the explanation.
Estimating prices of risk is a tricky business. Michael Schwert, finance professor at Wharton, approaches this by building a credit risk model accounting for the priority structure of debt, expected losses in the case of default, and secondary market illiquidity. The model does price bonds correctly, thus avoiding the "credit spread puzzle" known from previous research.
Comparing new US dollar loan facilities with outstanding bonds of similar maturity from the same firm for the period 1997-2017, he finds that banks seem to earn a substantial premium relative to the risk they bear. Please note that the cost of borrowing may be the same or even higher for the bond financing; we're talking about the risk-adjusted cost.
For instance: According to Moody's, the average recovery for term loans for this period was 76%, while senior secured bonds managed 51%. Those extra 25% ought to be worth something.
Fast forward some Greek letters explaining his credit model (I doubt I'd keep you glued) and behold: In a subsample of secured term loans to non-investment-grade companies, about half of the average loan spread is a premium above the cost of credit implied by the capital markets.
So, yes, in layman's terms, the banks earn a substantial premium, risk-adjusted, on their loans.
The math just doesn't add up. In professor Schwert's words, "costs of distress, bond issuance, and loan illiquidity must be implausibly high to justify the pricing of loans."
Here's one way of looking at it: Companies must place a high value on bank services beyond the mere provision of capital. As the former chairman of a brilliant little bank, and thus notoriously partial, I do believe this is a valid point. A bank loan, or rather a banking relationship, is a different product.
Here's another, though: Too few companies have explored their options in the bond market – especially in Europe, I might add, where bond financing is still less prevalent.
In the Nordics, at least, things look a bit different. Over the past decade, corporate IG issuance has doubled and HY issuance has quadrupled, according to DNB Markets. And, yes, we do expect more to come.
“RISK: The chance that you don’t know what you are doing when you think you do; the prerequisite for losing more money in a shorter period of time than you could ever have imagined possible. (…)”
Michael Schwert: "Does Borrowing from Banks Cost More than Borrowing from the Market?" The Journal of Finance, forthcoming