Category Archives: Finance

Is There Really A Corporate Debt Bubble That’s Ready To Burst?

By Jeffrey J. Peshut

December 3, 2018

Over the past several months, media headlines have been awash with dire warnings of a looming corporate debt bubble that is about to burst. Some of the more provocative headlines include:

From the perspective of Austrian Business Cycle Theory. this post will explore the questions of whether there really is a corporate debt bubble — and, if there is, when we can expect it to burst. But first, let’s define corporate debt.

Corporate Debt

According to Federal Reserve Statistical Release Z.1, Financial Accounts of the United States, the non-financial “corporate business debt” sector consists of all private for-profit domestic non-financial corporations. S Corporations, which have 35 or fewer stockholders and are taxed as if they were partnerships, are included in this sector. Corporate farms are also included. Holding companies and equity real estate investment trusts (REITs), which are considered financial businesses, are excluded from this sector.

Corporate Business Debt outstanding totaled $20.2 trillion at the end of 2017, an increase of $7.3 trillion from the cyclical low of $12.9 trillion at the end of 2009. (See Figure 1.) This reflects a 56.6% increase over that eight-year period.

Figure 1: Corporate Business Debt ($000,000) 1978 – 2017

The $20.2 trillion of outstanding Corporate Business Debt includes debt securities that include Corporate Bonds ($5.4 trillion), Municipal Securities ($568 billion) and Commercial Paper ($207 billion), Foreign Direct Investment in U.S. ($3.9 trillion), loans that include Depository Institution Loans ($1.0 trillion), Other Loans and Advances ($1.3 trillion) and Total Mortgages ($522 trillion), Trade Payables ($2.5 trillion) and Miscellaneous Liabilities ($4.6 trillion). (See Figure 2.)

Figure 2: Corporate Business Debt By Sector 2017

The year-over-year percentage growth of Corporate Business Debt from 1978 through 2017 is presented in Figure 3. This chart vividly illustrates the cycles in Corporate Business Debt over the past 40 years. Note the cyclical peaks in its growth rate of 12.8% in 1984, 14.3% in 2000, 9.26% in 2007 and what will likely be the peak for the current cycle of 7.95% in 2015 and the cyclical troughs in its growth rate of 6.33% in 1982, 2.12% in 1991, -.56% in 2003 and -2.43% in 2009. The cyclical trough for the current cycle has yet to be revealed.

Figure 3: Corporate Business Debt (YOY%) 1978 – 2017

Non-Corporate Debt

The non-financial “non-corporate business debt” sector consists of partnerships and limited liability companies (businesses that file IRS Form 1065), sole proprietorships (businesses that file IRS Schedule C) and individuals who receive rental income (income debt reported on IRS Schedule E). Non-corporate farms are included in this sector. Investment properties owned by individuals and the corresponding mortgages are also included in this sector.

Companies in this sector are not necessarily small, but they generally do not have access to the debt securities markets like companies in the corporate business debt sector and thus rely on loans from commercial banks, trade credit and other credit providers for funding. When it comes to dealing with finances in any industry, the idea of finding out as much as you can beforehand can make all the difference. From looking into the idea of income ratios when home buying, to even finding out how to deal with finances for your business, this is all vital information that we all should be aware of, especially as the economy is always changing.

Non-Corporate Business Debt outstanding totaled $7.5 trillion at the end of 2017, an increase of $1.9 trillion from the cyclical low of $5.6 trillion at the end of 2011. (See Figure 4.) This reflects a 33.5% increase over that six-year period.

Figure 4: Non-Corporate Business Debt ($000,000) 1978 – 2017

The $7.5 trillion of outstanding Non-Corporate Business Debt includes Total Mortgages ($3.8 trillion), loans that include Depository Institution Loans ($1.3 trillion), Other Loans and Advances ($206 billion), Trade Payables ($672 billion) and Unidentified Miscellaneous Liabilities ($1.4 trillion). (See Figure 5.)

Figure 5: Non-Corporate Business Debt By Sector 2017

Figure 6 presents the year-over-year percentage growth of Non-Corporate Business Debt from 1978 through 2017. Similar to Figure 3, Figure 6 clearly shows the cycles in Non-Corporate Business Debt over the past 40 years. Note the cyclical peaks in its growth rate of 14.12% in 1984, 16.50% in 1998, 14.93% in 2005 and what will likely be the peak for the current cycle of 6.22% in 2014 and the cyclical troughs in its growth rate of 4.30% in 1987, -1.58% in 1991, 2.18% in 2003 and -1.11% in 2009. Again, the cyclical trough for the current cycle has yet to be revealed.

Figure 6: Non-Corporate Business Debt (YOY%) 1978 – 2017

Combined, the $20.2 trillion of “corporate business debt” and the $7.5 trillion of “non-corporate business debt” make up the total business debt of $27.7 trillion.

True Money Supply

Followers of the Austrian School of economic thought and regular readers of RealForecasts.com understand that changes in monetary policy by the Federal Reserve System’s Federal Open Market Committee (FOMC) and the resulting rate of change of U.S. Base Money, Commercial and Consumer Lending and the Money Supply can be used as leading indicators to accurately forecast changes in the economy, financial markets and real estate markets. (See, Does The Federal Reserve Really Create The Boom/Bust Cycle?) Therefore, to determine whether there is a corporate debt bubble that’s ready to burst, it’s helpful to look to changes in the rate of growth of the Austrian measure of the money supply, also known as the True Money Supply or TMS.

At the end of 2017, the True Money Supply totaled $13.1 trillion, an increase of $8.0 trillion from the cyclical low of $5.1 trillion at the end of 2006. (See Figure 7.) This reflects an astounding 156.9% increase over that 11-year period. To put that into perspective, TMS increased from the cyclical low of $3.0 trillion in 2000 to $5.1 trillion in 2006, an increase of “only” $2.1 trillion or 70% during the height of the most recent housing bubble. Is it any wonder that we’ve seen such exponential increases in asset values since the institution of Quantitative Easing?

Figure 7: True Money Supply ($000,000) 1978 – 2017

The year-over-year percentage growth of TMS is shown in Figure 8. Note the cyclical peaks in the TMS growth rate of 36.66% in 1983, 13.27% in 1992, 18.00% in 2001, and what will likely be the peak for the current cycle of 14.49% in 2011. Also note the cyclical troughs in the TMS growth rate of -1.63% in 1989, -2.11 in 1994, 2.61% in 2000 and 1.66% in 2006. Based upon the precipitous drop in the TMS growth rate over the past year and the Fed’s current monetary stance, the next cyclical trough in the TMS growth rate is likely not too far off.

Figure 8: True Money Supply (YOY%) 1978 – 2017

Corporate Debt vs. True Money Supply

The relationship between changes in the growth rate of Corporate Business Debt and the True Money Supply is set forth in Figure 9. Generally, the trough in the growth rate of Corporate Business Debt lags the trough in TMS by about three years. If this relationship holds true for the current cycle, the growth rate for Corporate Business Debt should reach its next trough in the 2021 to 2022 time-frame.

Figure 9: Corporate Business Debt (YOY%) vs. True Money Supply (YOY%) 1978 – 2017

Conclusion

Although the analysis presented in this post indicates that the growth rate of Corporate Business Debt reached its cyclical peak in 2015 and that the growth rate of TMS is nearing its cyclical trough, the three-year lag between the growth rate of Corporate Business Debt and the growth rate of TMS suggest that the growth rate of Corporate Business Debt won’t reach its next cyclical trough until the 2021 to 2022 time-frame. Therefore, warnings that a corporate debt bubble is ready to burst seem premature. However, if you are worried that your company or business may suffer from this, it may be worth looking into having a debt collection firm, like dynamic collections, readily available for you to use to ensure you are not owed a large sum of money from multiple places.

Where Are The Real Estate Credit Markets In Their Cycles?

By Jeffrey J. Peshut

September 14, 2015

In its last post, Can Real Estate Investors Manage Through The Boom/Bust Cycle?, RealForecasts.com presented alternative strategies that real estate investors can employ to manage through the boom/bust cycle, depending upon where the real estate capital markets and real estate property markets are in their cycles. Real Estate in Colorado for example may have different forecasts to other states, and to view their properties you can click here. That of course begs the question, “Where are the real estate capital markets and real estate property markets in their cycles today?” This post will address the question of where one sector of the real estate capital markets — the real estate credit markets — are in their cycles.

Real Estate Credit Market Cycles

The real estate credit markets can be divided into three separate categories — commercial mortgage debt, multi-family residential mortgage debt and and single-family residential mortgage debt. RealForecasts.com uses changes in the level of mortgage debt outstanding to track the cycle for each category. This can be a lot to take in, even for someone who is just looking to buy or sell property. With this being said, you don’t have to struggle to understand any of this on your own. That’s why specialists such as Eddie Yan are here for. We all know that the buying/selling process can be quite stressful, but with help from people who know what they are talking about, it couldn’t get any easier.

For example, Figure 1 shows commercial mortgage debt outstanding from 1978 to 2014. The last cycle for commercial mortgage debt began in 1995 at a level of $733.8 billion before peaking in 2008 at a level of $2.58 trillion. As the supply of credit contracted after the Great Financial Crisis, commercial mortgage debt outstanding also contracted, reaching a trough of $2.23 trillion — and the end of the cycle — in 2012. Since the start of the current cycle in 2013, commercial mortgage debt outstanding has increased to $2.39 trillion, but has yet to recover to its 2008 peak. In terms of a commercial mortgage, there are some companies out there who can take the mortgage note off your hands and put your commercial property portfolio for sale. This way, you can make a bit more money to go towards your business.

Figure 1: Commercial Mortgage Debt Outstanding ($ Billions) 1978 – 2014

Commercial Mortgage Debt Outstanding - $B- 1978 to 2014

The year-over-year growth rate of commercial mortgage debt outstanding since 1978 is shown in Figure 2. The rate of growth averaged 7.26% from 1978 to 2014. but accelerated to almost 15% in both 1999 and 2005.

Figure 2: Commercial Mortgage Debt Outstanding (YOY%) 1978 – 2014

Commercial Mortgage Debt Outstanding - YOY - 1978 to 2014

Figure 3 presents multifamily mortgage debt outstanding between 1978 and 2014. The last cycle for multifamily mortgage debt began in 1994 at a level of $268.2 billion and increased to a peak of $855.2 billion in 2009. After the Great Financial Crisis, however, multifamily mortgage debt outstanding decreased only slightly to $852.2 billion in 2010. Multifamily mortgage debt began increasing again — and the new cycle began — in 2011 and had reached $998.6 billion as of the end of 2014.

Figure 3: Multifamily Mortgage Debt Outstanding ($ Billions) 1978 – 2014

Multi-Family Mortgage Debt Outstanding - $B - 1978 - 2014

Figure 4 presents the year-over-year growth rate of multifamily mortgage debt since 1978. Although the rate of growth averaged only 6.1% from 1978 to 2014. growth accelerated to 12.2% in 1999 and 2007 and 15% in 2003.

Figure 4: Multifamily Mortgage Debt Outstanding (YOY%) 1978 – 2014

Multi-Family Mortgage Debt Outstanding - YOY - 1978 - 2014

Finally, Figure 5 shows single family mortgage debt outstanding from 1978 to 2014. The most recent cycle for single family mortgage debt began in 1995 at a level of $3.45 trillion before peaking in 2007 at a level of $11.24 trillion — an increase of 226%. Single family mortgage debt outstanding contracted significantly after the Great Financial Crisis, decreasing to $9.89 trillion at the end of 2014. At this point, it’s not clear whether the last cycle has ended and the new cycle has begun. Regardless, it will still be a number of years before single family mortgage debt outstanding returns to its 2007 peak.

Figure 5: Single Family Mortgage Debt Outstanding ($ Billions) 1978 – 2014

Single Family Mortgage Debt Outstanding - $B - 1978 - 2014

Figure 6 presents the year-over-year growth rate of single family mortgage debt outstanding since 1978. Not only did the rate of growth average almost 8% from 1978 to 2014. growth accelerated to as high as 15.5% in 1985 and 14.3% in 2004. Perhaps even more importantly, in the last year of the cycle that ended in 1995, single family mortgage debt outstanding never contracted and in fact grew at a rate of 5.1%.

Figure 6: Single Family Mortgage Debt Outstanding (YOY%) 1978 – 2014

Single Family Mortgage Debt Outstanding - YOY - 1978 - 2014

Comparing Figure 6 to Figure 4 and Figure 2 shows that the multifamily mortgage market is much farther along in its current cycle than either the commercial mortgage market or the single family mortgage market. The marked difference in size between the single family mortgage debt market and the multifamily mortgage debt market — the single family mortgage debt market is approximately 10 times the size of the multifamily mortgage debt market — may help to explain the accelerated growth in multifamily mortgage debt outstanding since 2010.

Government Sponsored Enterprises (GSE’s) like Fannie Mae and Freddie Mac are not only the largest source of lending capital for single-family homes, but they are also the largest source of lending capital for apartment homes. The Fed’s attempt to re-inflate the single-family residential market by acquiring residential mortgage-backed securities from Fannie Mae and Freddie Mac has arguably had the unintended consequence of flooding the multifamily residential market with an over-abundance of inexpensive mortgage debt. This in turn could result in the over-building and over-supply of apartment homes.

Real Estate Credit Market Cycles and Cap Rate Cycles

Recently, real estate pundits have been speculating about the impact of the Fed’s expected increase in the Fed Funds Target Rate on real estate mortgage rates and real estate cap rates. Mostly overlooked in this discussion is the impact of an increase in the level of mortgage debt outstanding on cap rates.

To that point, Figure 7 compares the NCREIF Property Index (NPI) Income Return — as a proxy for cap rates on commercial and multifamily properties — to commercial and multifamily mortgage debt outstanding from 1978 to 2014. Note the strong inverse correlation between the NPI Income Return and the level of commercial and multifamily residential mortgage debt outstanding.

For example, as commercial and multifamily mortgage debt outstanding increased from $374.4 billion in 1979 to $1.11 trillion in 1990, the NPI Income Return decreased from 8.95% to 6.59%. Then, as commercial and multifamily mortgage debt outstanding contracted from $1.11 trillion in 1990 to $990.9 billion in 1994, the NPI Income Return increased from 6.59% in 1990 to 9.13% in 1995. The credit cycle during the 17-year period from 1979 to 1995 has been referred to as the “S&L Era” to reflect the new sources of commercial and multifamily mortgage debt outstanding during that time frame.

As commercial and multifamily mortgage debt outstanding increased from $1.08 trillion in 1995 to $3.4 trillion in 2008, the NPI Income Return decreased from 9.13% to 5.13%. Then, as commercial and multifamily mortgage debt outstanding contracted from $3.4 trillion in 2008 to $3.1 trillion in 2011, the NPI Income Return increased from 5.13% in 2008 to 6.76% in 2010. The credit cycle during the 16-year period from 1995 to 2010 has been referred to as the “CMBS Era”, again to reflect the new sources of commercial and multifamily mortgage debt outstanding during that period.

Since the beginning of the current real estate credit cycle, commercial and multifamily mortgage debt outstanding has increased from $3.12 trillion in 2011 to $3.38 trillion in 2014. In turn, the NPI Income Return has decreased from 6.76% in 2010 to 5.36% in 2014.

Figure 7: NPI Income Return (%) v. Commercial and Multi-Family Mortgage Debt Outstanding 1978 – 2014

NPI Income Return v. Comm and MF Mortgage Debt Outstanding 1978 - 2014

Although it is hard to believe that it can go much lower, this analysis suggests that the NPI Income Return will in fact continue to trend downward as commercial and multifamily mortgage debt outstanding continues to increase during the current real estate credit cycle. It’s less clear at this point, however, what will be the new sources of commercial and multifamily mortgage debt outstanding during the current cycle. Those that are suggesting that this will become know as the “Shadow Banking Era” — referring to non-chartered lending institutions — could be on the right track.

Can Real Estate Investors Manage Through The Boom/Bust Cycle?

By Jeffrey J. Peshut

August 2, 2015

With the growth rate of the True Money Supply (TMS) expected to continue its inexorable decline towards the next financial crisis, what steps can real estate investors take to manage through the bust phase of the cycle? This post will address that question. Whatever the case, firms like Wagenseller law will most likely be very busy in the coming months with a heap of litigation cases. But first, let’s take a look at what’s been happening with the TMS growth rate over the past several months.

TMS Growth Rate

For June, 2015, the year-over-year growth rate of TMS was 8.26%. (See Figure 1) This was up from 7.72% in the previous month and the highest level reported since the end of the QE3 “Taper” in October of 2014. The lowest level reported since October was 6.53% in March of this year.

Figure 1: True Money Supply (YOY%) 01/01/78 – 06/01/15

True Money Supply - YOY - 01-01-78 - 06-01-15

Despite this recent uptick, RealForecasts.com expects the growth rate of TMS to continue the downward trend shown by the arrow in Figure 1, especially once the FOMC raises the Fed Funds Target Rate above its current ceiling of 25 bps later this year. For a more in-depth discussion see, How Will The End Of Quantitative Easing Impact The True Money Supply Growth Rate?

What Steps Can Real Estate Investors Take To Manage Through The Next Bust?

The two most important steps that real estate investors can take to manage through the next bust is to first shift the way they look at the economy and financial markets from “linear” to “cyclical” and then shift their investment mindset from “relative” to “absolute”. The use of marketing would be a good step forward for the field of real estate. There are so many marketing ideas for real estate, as the main focus revolves around the idea of connecting with customers. What better way to do this than through the use of the internet and marketing tools. Real estate investment is not something that something to be taken lightly. In fact, seeking advice from experts should also be sought prior to any decision being made. Anyone who feels they would need financial assistance prior to investing might like to speak to a Charlotte hard money lender. Research is critical when making such a monumental decision.

It’s human nature to forecast in a linear fashion. If the economy and financial markets are going up, it’s natural for investors to forecast that they will stay up and even continue to go up in the future. If the economy and financial markets are going down, it’s also natural for investors to forecast that they will stay down and even continue to go down in the future.

Yet the economy and financial markets don’t behave that way. They are nothing if not cyclical.

Also, most investors — especially institutional investors — have adopted a relative return mindset for their portfolios and measure their performance and the performance of their investment managers against market benchmarks or indices. A relative return strategy performs well, however, only when the overall market performs well. That said, if the overall market doesn’t perform well, but the investor or manager outperforms the market benchmark or index, they are still deemed to have performed well. That sounds good in theory, but as the saying goes, “you can’t eat relative performance”. Practically speaking, even if an investor’s negative returns weren’t as great as the negative returns posted by the market as a whole, they still lost money.

A portfolio based upon an absolute return strategy, on the other hand, is designed to provide positive returns regardless of the direction of the overall market. Investors following an absolute return strategy will generate these positive returns by investing up and down the real estate capital structure (common equity to senior debt) and back and forth along the real estate risk/return continuum (core to opportunistic), depending upon where the real estate capital markets and real estate property markets are in their cycles. Figure 2 shows the universe of investment alternatives available to real estate investors by the risk profile of the investment and the investor’s position in the capital structure for the investment.

Figure 2: Real Estate Capital Structure and Real Estate Risk/Return Continuum

Real Estate Capital Structure and Real Estate Risk-Return Continuum

The following section indicates where investors should position themselves in the capital structure based upon where the Real Estate Capital Markets are in their cycle.

Real Estate Capital Markets Cycle

If the Real Estate Capital Markets are either currently in or forecasted to move into the Expansion phase of the cycle, invest in real estate equity investments to take advantage of cap rate compression and appreciating capital values. If the Real Estate Capital Markets are in or forecasted to move into the Contraction phase of the cycle, rotate out of equity investments and into real estate debt investments to avoid cap rate decompression and depreciating capital values. (See Figure 3) Depending upon the investor’s risk tolerance and return objectives, equity investments can take the form of either preferred equity or common equity. Debt investments can take the form of senior debt or mezzanine debt.

Figure 3: Real Estate Capital Markets Cycle – Indicated Investment Types

Real Estate Capital Markets - Indicated Investments

The following section indicates where investors should position themselves on the real estate risk/return continuum based upon where the Real Estate Leasing Markets are in their cycle.

Real Estate Leasing Markets Cycle

When the Real Estate Leasing Markets are in the Recovery phase of the cycle, invest in existing core, core plus and value–added investments to take advantage of rising occupancy rates, lease rates and capital values. During the Expansion phase of the Leasing Markets’ cycle, add opportunistic investments in new developments. If the Real Estate Leasing Markets are forecasted to move into the Recession and Contraction phases of the cycle, sell properties, pay down debt and rotate into core risk/return investments. (See Figure 4)

Figure 4: Real Estate Leasing Markets Cycle – Indicated Investment Types

Real Estate Leasing Markets - Indicated Investments

Takeaways

RealForecasts.com expects that the growth of TMS will continue its downward trend in the months ahead, especially once the FOMC raises the Fed Funds Target Rate above its current ceiling of 25 bps later this year. Based upon the current trajectory of this trend, and the Fed’s current policy stance, it looks like the next credit crisis could occur during the second half of 2016. Of course, this forecast could change if the Fed changes its policy stance or if the commercial banks change the pace of lending activity.

In the meantime, it’s not too early for real estate investors to take advantage of the robust capital markets environment to begin selling some of their under-performing and less-strategic assets and using the proceeds to reduce the leverage on their portfolios. By “dealing from the bottom of the deck” and reducing leverage, they will be improving the risk profile of their portfolios in anticipation of — and not in reaction to — the next downturn.

Many thanks to Michael Pollaro at The Contrarian Take for the TMS data used in this post.