Regulatory unease at high-risk bonds

Record sales of high-yield payment-in-kind bonds is triggering uneasiness among international regulators who are concerned investors may suffer losses when central banks tighten monetary policy.

Issuance of the notes, which give borrowers the option to repay interest with more debt, more than doubled this year to $16.5bn (€12bn) from $6.5bn (€4.7bn) in 2012, according to data compiled by Bloomberg. About 30% of issuers before the 2008 financial crisis have since defaulted, the Bank for International Settlements said in its quarterly review.

Companies are taking advantage of investor demand for riskier debt as central bank stimulus measures suppress interest rates and defaults approach historic lows. The average yield on junk-rated corporate bonds fell to a record 5.94% worldwide in May, Bank of America Merrill Lynch index data show, while global default rates dropped to 2.8% in October from 3.2% a year earlier, according to a Moody’s report.

“Low interest rates on benchmark bonds have driven investors to search for yield by extending credit on progressively looser terms to firms in the riskier part of the spectrum,” according to the report from the Basel-based Bank for International Settlements.

“This can facilitate refinancing and keep troubled borrowers afloat. Its sustainability will no doubt be tested by the eventual normalisation of the monetary policy stance.”

Sales of payment-in-kind bonds last peaked in 2007 when companies issued $11.1bn of the securities. Offerings fell to $5.4bn in 2008 and tumbled to $2.7bn in 2010, the data show.


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