By David Zeiler
With interest rates at or near historic lows, companies have been issuing corporate bonds at a breathtaking pace, setting a weekly record this month.
Excluding financial services companies, corporate borrowing for the week ending May 20 reached $29.7 billion, which beat the previous weekly record of $29.04 billion set last September.
With the U.S. Federal Reserve buying up government debt, yields on such benchmarks as the 10-year Treasury note fell from 3.725% in early February to 3.118% in mid-May. Corporate bonds are priced against Treasuries, so when yields fall on government bonds it makes corporate borrowing cheaper.
The unusually low interest rates make acquiring debt very attractive even for companies with no immediate need for the money.
"This is a great time to be a corporate debt issuer, when everyone wants to be your lender and you don't have a pressing need to borrow," wrote Bank of America Corp. (BAC) credit strategist Oleg Melentyev in a May 18 note to clients.
The recent urgency to sell debt arises from companies anticipating the end of the Fed's second round of quantitative easing (QE2) in June. If the Fed ends QE2 as expected, yields will begin to rise and with them the cost of borrowing.
"If you are standing on the North Pole, any direction you walk is south," Martin Fridson, global credit strategist at BNP Paribas SA (OTCPK:BNPQF) Asset Management, told The Financial Times. "When you have optimal financing conditions, the thing to do is get your deal done now."
Appetite for Debt
Despite the apparent disadvantage to buyers of debt at a time when rates have nowhere to go but up, the bonds have had a surplus of orders -- Google had more than $9 billion of orders for its $3.2 billion offering of 3-year, 5-year and 10-year notes.
"Given the resurgence in inflation, that is already apparent in official figures (which tend to lag the reality) I certainly think the buyers are fools -- if I were a bond investor right now I'd be keeping maturities as short as possible, in the three to five year range," said Money Morning contributor Martin Hutchinson.
But investors, leery of the volatile stock market and looking for a better return than they can get on government bonds, keep buying up corporate debt.
"Corporate bonds are still our favorite sector," Wilmer Stith, portfolio manager at MTB Investment Advisors, told The Wall Street Journal.
The amount of debt companies have issued this year is staggering. As of May 18, companies with investment-grade ratings had issued $392 billion of bonds, an increase of 30% over the same period last year.
Companies with top credit ratings, such as Johnson & Johnson (AAA), have been just as likely as those with junk ratings, such as Chrysler Group LLC and EchoStar Corporation (SATS), to borrow in a big way.
How big? In the week of May 20 alone, Johnson & Johnson sold $3.75 billion in bonds; Texas Instruments Inc. (TXN), $3.5 billion; Chrysler, $3.2 billion; EchoStar, $2 billion; and Alpha Natural Resources (ANR), $1.5 billion.
When Google conducted its first-ever bond sale on May 16, many wondered why a company with $37 billion in cash would want to borrow money. The company said it planned to use its bonds to replace existing commercial paper.
But that's far from the only reason Google could have had to enter the bond market. And the scale of this year's debt spree, which featured many large techs -- Microsoft, International Business Machines Corp. (IBM), Cisco Systems Inc. (CSCO), and Dell Inc. (DELL) - suggests an assortment of motives.
"Many tech companies have looked to raise capital in the [U.S. debt] market over the past year, for a multiple of reasons, including acquisitions, the maturing of businesses and the inability to tap offshore cash without tax consequences," Keith Harman, a managing director in debt capital markets at Bank of America Merrill Lynch told Reuters.
The issue of offshore cash is a significant one. For many companies, offshore money accounts for the bulk of their cash. About 46% of Google's cash is overseas; 90% of Cisco's and virtually all of Microsoft's.
Because of a reluctance to pay the 35% U.S. corporate tax on that money, that cash remains offshore and unavailable for many uses, such as stock buybacks and infrastructure investment. (Microsoft used some of its offshore cash to buy Luxembourg-based Skype earlier this month.)
So companies are selling bonds.
"For companies, borrowing long-term at today's low rates makes a lot of sense," said Hutchinson. "You've locked in a chunk of your capital at very low costs for 30 years. Google knows the future won't be as bonanza-like as the past, and it knows it will need to buy fledgling companies to stay ahead on the curve, so why not lock up an extra couple of billion of firepower while it's cheap?"