If you enjoyed the thrills, spills and chills of the last credit crisis, I have great news. The makings of the next one are looming – large – right in front of us.
In a report last week, Standard & Poor's said the world faces a mountain of roughly $46-trillion (U.S.) in corporate debt needs between now and the end of 2016. In addition to a $30-trillion "wall" of corporate debt that will come due and require refinancing, S&P estimated that corporations worldwide will need between $13-trillion and $16-trillion of new debt to meet their capital spending and working-capital needs – essentially, to finance growth.
Actually, those numbers are just for the five major borrowing markets in the world (the United States, the euro zone, Britain, China and Japan). A true global estimate would be even bigger. (But what's a few trillion bucks among friends, eh?)
"This demand for funds will potentially compound the credit rationing that may occur as banks seek to restructure their balance sheets, and bond and equity investors reassess their risk-return thresholds. These factors, amid the current euro zone crisis, a soft U.S. economic recovery following the Great Recession, and the prospect of slowing Chinese growth, raise the downside risk of a perfect storm for credit markets, in our view," S&P wrote.
Such a "perfect storm" is, essentially, another credit crunch. As you recall from the last one, those pesky things have a knack for choking off growth, fuelling liquidation of financial assets and generally making everyone very nervous – all bad news for the markets and the economy.
And S&P warned that the forces used to counter the last credit crunch – namely, an opening of the fiscal and monetary floodgates – may not be there next time around.
"Governments and banking regulators are now not as well placed to counter another perfect storm scenario, given that they have already expended so much of their fiscal and monetary arsenal to mitigate the problems arising in recent years," it said.
Now, S&P isn't saying this is a done deal; it believes the financial sector has recovered sufficiently to at least be able to clear the $30-trillion refinancing wall. It helps that corporate borrowers generally look more credit-worthy now than before the financial crisis, as the majority of them have improved their balance sheets by building up higher cash balances.
"However, the $13-trillion to $16-trillion required to fund future growth could be more at risk," it said.
More than three-quarters of all global corporate debt is in the form of bank loans. Banks in most of these major lending regions (China being the well-heeled notable exception) face both new regulatory restraints and still-delicate balance sheets, which may prompt them to keep a tighter reign on their corporate lending than in past cycles. If the current euro zone sovereign crisis were to escalate or the economic slowdowns of China and Europe to broaden, already-tight lending policies could all but dry up.
"Given our expectation that certain borrowers may find the availability of bank financing more limited than in the past – and when available, at a higher cost with likely more onerous terms and conditions – alternative providers of debt financing may be set for a new challenge," S&P said.
That means the bond markets – which may have a lot of trouble absorbing that much new supply. For example, if European companies were forced to turn to the bond market to raise, say, 50 per cent of their new funding needs (compared with 15 per cent historically), that would mean more than $200-billion per year of new issues; only twice in the past decade have European corporate bond issues even topped $100-billion in a year.
While this suggests potential for tremendous growth in corporate bond markets, it also implies a lot of competition for a slice of the bond-financing pie. Companies are going to have to pay higher interest rates to secure their funding, and some won't be able to raise the money they need on terms they can afford. Higher rates, higher borrowing costs and insufficient available capital are all, at very least, substantial headwinds for healthy, sustainable economic and equity-market growth.
And it would all be exacerbated by heightened risk and economic deterioration, as Europe is already demonstrating. European Central Bank data show that banks' corporate lending standards have tightened considerably since last fall.
"At best, we are currently at a fragile peace," S&P concluded. "At worst, we have created the makings of a perfect storm for the future."
David Parkinson