The document discusses how corporate credit is cyclical and the reasons for this cyclicality. It finds that both demand for and supply of corporate credit vary over the business cycle. On the demand side, firms wish to invest and borrow less during recessions. On the supply side, evidence shows that bank lending varies more over the cycle than bond issuance, indicating banks constrain credit more in downturns. The document also examines how "reaching for yield" behaviors by institutional investors in good economic times can exacerbate this credit cyclicality.

1. Corporate credit and business cycles
Bo Becker
Stockholm School of Economics and NBER

2. Corporate credit
• Important to firms
• Important to investment in new physical and
intangible capital
• Important to investors (households, retirement
savings, insurance industry, banks)

3. Corporate credit is cyclical: US
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
1953:Q1
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2011:Q1
2012:Q1
Growth of stock of
corporate debt
Source: US Flow of Funds
NBER Recessions

4. Corporate credit is cyclical: Europe
Source: Mario Draghi, ”Euro area economic situation and the foundations for growth”, March 14, 2013

5. Reason for
cyclicality
What happens in bad
times
Implications for fiscal
and monetary policy
Demand is cyclical Firms don’t want to invest Support firms (not banks)
Supply is cyclical Banks are
constrained, won’t lend
(Holmström Tirole 1997)
Non-standard measures
that support bank
equity/lending
= Government
investment in banks such
as TARP
Matching frictions are
cyclical
Harder to separate good
from bad credit risks, or
firms lack equity to support
borrowing (Bernanke and
Gertler 1989)
?
Reasons for cyclicality

6. Friction cyclicality – what does the evidence say?
• Market frictions
- Information or agency
• [Information] Worse lemon problems in borrowing
market
- Banks have considerable information at all times
- Perhaps not that important?
• [Agency] Not much direct evidence
- Curious, since Bernanke-Gertler is standard reference

7. Demand cyclicality – what does the evidence say?
• Obvious mechanism: firms wish to invest less in bad times, need
less funding
• Evidence is supportive
- Even the least constrained firms in the economy tend to invest less in
recessions
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0% Ex: Wal-mart capital
expenditure over assets, 4Q

8. Supply cyclicality – what does the evidence say?
• Kashyap, Stein and Wilcox (1993) showed that US firms
issue more commercial paper and borrow less from banks
in bad times
- But not the same set of firms borrow through time (Kashyap
and Stein 1999)
- Could be there are large firms (CP) and small firms (loans)
- In bad times, large firms do bigger share of investment
• To address, need to keep firms fixed: compare same firm
through time
• Becker Ivashina (JME, fothc.) compares bonds and
syndicated loans issued for large US firms 1991-2011
- Bond market acts as thermometer for banks
- A given firm often gets a loan in good times, issues bonds in
bad times

9. Lending more volatile than bond issuance
Source: Becker Ivashina (2013 European Financial Review)

10. Also true in Europe
Source: Becker Ivashina (2012 European Financial Review)

11. “I am skeptical that one can say much about time variation in the
pricing of credit--as opposed to equities--without focusing on the
roles of institutions and incentives. The premise here is that since
credit decisions are almost always delegated to agents inside
banks, mutual funds, insurance companies, pension funds, hedge
funds, and so forth, any effort to analyze the pricing of credit has
to take into account not only household preferences and
beliefs, but also the incentives facing the agents actually making
the decisions. And these incentives are in turn shaped by the rules
of the game, which include regulations, accounting standards, and
a range of performance-measurement, governance, and
compensation structures.”
Jeremy Stein, Feb 7, 2013
Why is supply of loans cyclical?

12. Why is supply of loans cyclical?
• Household preferences and beliefs
- Irrational behavior
- Animal spirits
- Incomplete information
• Rules of the game
- Regulation
- Accounting standards
- Performance-measurement
- Governance
- Compensation structures

13. Reaching-for-yield
“…looking for seemingly safe but higher-yielding debt-like
securities”
Raghuram Rajan, 2010, Fault Lines
“[A] sustained period of very low and stable yields may
incent a phenomenon commonly referred to as ‘reaching
for yield,’ in which investors seek higher returns by
purchasing assets with greater duration or increased credit
risk”
Janet Yellen, 2011
“ fairly significant pattern of reaching-for-yield behavior
emerging in corporate credit”
Jeremy Stein, 2013

14. Reaching-for-yield in insurance portfolios
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
NAIC 1 (AAA-A) NAIC 2 (BBB) NAIC 3 (BB) NAIC 4 (B) NAIC 5 (CCC)
• US insurers focus on
safe corporate bonds
• In part, response to
capital requirements:
lower risk = less capital
• Within a capital
bucket, more of risky
bonds
• Reach for yield
- Build up of risk in
good times
- May add to
cyclicality
0.3%Cap. req.: 0.96% 3.39% 7.38% 16.96%
Insurers’ acquisitions of new corporate bonds pre-crisis
Insurers’ acquisitions of new IG corporate bonds pre-crisis
Source: Becker Ivashina (2013, accepted Journal of Finance)
55%
60%
65%
70%
75%
80%
85%
90%
Yield spread
1 (safest)
2
3
4 (riskiest)

15. Reaching for yield exacerbates credit cycles
Loading up on risk in good times
Stepping back in crisis
Appetite comes back
Source: Becker Ivashina (2013 Credit Flux)