Debt Woes Continue
Solid, investment-grade companies, such as General Mills, are normally able to sell debt like Cheerios. But with the freezing up of credit markets worldwide, even the strongest firms are shying away. Between the time it takes and the increasing costs, it is a decreasingly attractive option right now.
FINANCES by Gabrielle Coppola | Bloomberg News
Before credit markets from New York to London seized up a year ago, investment-grade companies could sell record amounts of debt in days. It took Tyco Electronics Ltd. Treasurer Mario Calastri 12 months to complete the bond sale he began last July.
"In the current rate environment, nobody really wants to stick their neck out," Calastri, 51, says. He's one of more than 60 treasurers forced to wait months, reduce borrowings or accept less favorable terms as the turmoil that began a year ago stifles investor demand.
Issuers are paying about the highest borrowing costs since the last recession in 2001, according to Merrill Lynch & Co.'s U.S. Corporate & High Yield Master Index, as the lowest Federal funds rate in four years does little to pump up credit. The bond-market headwinds buffeting companies from Tyco to General Mills Inc. may thwart efforts by Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson to keep the economy out of recession with interest-rate cuts, stimulus checks and increased housing cash.
U.S. corporate-bond sales have dropped 11% to $640 billion in the past year as the number of issuers shrank almost a third to about 660, according to Bloomberg data.
At least 60 borrowers pulled debt sales since credit markets froze, according to data compiled by Bloomberg. The yield gap between companies' debt and U.S. Treasuries soared as high as 421 basis points, the most in almost six years, according to Merrill Lynch's index. Companies are defaulting at the highest rate in more than two years, according to credit-rating company Standard & Poor's.
'Fever hasn't broken'
Companies including telephone-service provider Sprint Corp., of Overland Park, Kan.; New York-based specialty-finance company CIT Group Inc. and automaker Porsche Automobile Holding SE in Stuttgart, Germany, tapped bank credit lines this year as bond and short-term debt issuance dried up. The market for corporate commercial paper, securities maturing in nine months or less, has contracted 22% since its August peak to a two- year low of $1.73 trillion, according to the Federal Reserve.
"The fever hasn't broken yet," says Lakshman Achuthan, managing director of the Economic Cycle Research Institute in New York. "The Fed is trying to address this. The question remains how effective it has been."
Tyco Electronics' Calastri offered inducements to lure buyers, including bowing to investor demands to pay a higher interest rate if the Bermuda-based electric-connector maker were to be downgraded. The company's debt is rated Baa2 by Moody's Investors Service and BBB by S&P and Fitch Ratings.
Quick as Cheerios
While General Mills, the second-largest U.S. cereal maker, sold $750 million of bonds on March 12, it scrapped plans for 10-year notes in favor of seven-year debt. An unexpected rise in yields over U.S. Treasuries made the longer-term borrowing too expensive, Treasurer Daralyn Peifer says.
The shorter-term borrowing may be less attractive than 10-year bonds to some borrowers because it forces them to return to markets sooner to refinance.
Getting the deal done took two months of waiting while demand plunged in January and February, the treasurer says.
"We basically watched, day by day by day, for months and waited for a perfect window," Peifer says. "And, lo and behold, we got a half a window."
The company paid 240 basis points more than U.S. Treasuries, compared with 95 basis points on 10-year debt in January last year. General Mills returned to sell $700 million of five-year bonds last week with a spread of 205 basis points, the most it has paid above Treasuries on that maturity. A basis point is 0.01 percentage point.
Only last year, Minneapolis-based General Mills could sell bonds almost as fast as Cheerios, the breakfast cereal it began making in 1941. Companies were selling an average $26 billion of bonds a week and investment-grade borrowers were paying yields over Treasuries of an average 91 basis points.
The company is rated Baa1 by Moody's and BBB+ by S&P.
Investors, flush with cash, were so eager to buy corporate debt they agreed to purchase bonds that included few provisions, or covenants, dictating the amount a company could borrow or providing extra payments, known as step ups, if an issuer were downgraded.
Then two Bear Stearns Cos. hedge funds imploded in June as defaults on subprime mortgages reached record levels, prompting investors to flee all but the safest debt. A year ago this week, Paris-based BNP Paribas SA halted withdrawals from three investment funds and the European Central Bank pumped unlimited cash into the banking system for the first time to relieve the credit crunch.
The Fed cut the discount rate, the benchmark at which it makes direct loans to banks, 50 basis points to 5.75% the next week, the first of nine such reductions.
As markets froze, investors, bankers and company treasurers were forecasting no more than a few tough months.
"We thought it was kind of a second-half-of-2007 issue," says Brad Lutz, a vice-president of investment research at Declaration Management and Research in McLean, Virginia, which oversees $21 billion in fixed-income assets. "That's bled into the third quarter of 2008."
Lutz says he isn't buying most company bonds. The slowing economy and rising defaults may limit returns on company debt, he says.
Default rates may climb as high as 10.9% by 2010, the highest since the last recession in 2001, compared with 2% during the past 12 months, according to Martin Fridson, chief executive officer of Fridson Investment Advisors in New York.
The squeeze is being felt around the globe. European corporate debt sales tumbled 19%, to 476 billion euros ($741 billion) in the first seven months of 2008. In Asia, offerings are down 51% to $14.9 billion.
Joung Kyu Kim, a funding manager at Seoul-based Woori Bank, canceled a $500 million bond sale in February as borrowing costs rose. Woori, a unit of South Korea's third-largest financial services company, may instead take out bank loans.
"I hope the market will improve in the second half of the year but negative sentiment is still prevalent," Kim says in an interview. Woori's senior debt is rated A1 by Moody's Investors Service, the sixth level of investment grade, and two steps lower by S&P.
Investment-grade ratings are the top 10 rankings given to companies, ranging from AAA to BBB- at S&P and Aaa to Baa3 at Moody's.
Bond demand increased from March to May as investors bet the worst of the crunch was past. Investment-grade sales reached a record $122.3 billion in April and $128.5 billion in May.
In March, after Bear Stearns was bailed out, Merrill Lynch completed a $7 billion offering, its biggest, and ArcelorMittal, the world's largest steelmaker, sold a record $3 billion of debt. Sales this year still exceed those in the same period of 2006.
Merrill Lynch, based in New York, is rated A2 by Moody's and A by S&P. Luxembourg-based ArcelorMittal is rated Baa2 by Moody's and BBB+ by S&P.
Selling debt now is "like a surgical-strike campaign," says Jim Esposito, global head of the investment-grade business at Goldman Sachs Group Inc. "The prudent course of action is to get in and out quickly, because windows of opportunity don't last very long."
Some companies are prying the windows open by offering investors more favorable terms.
At least 14% of investment-grade bonds sold this year included so-called poison-put provisions, such as those offered by Tyco Electronics, allowing bondholders to sell the debt back. That compares with 11% offering the feature in the same period last year, Bloomberg data show. About 10% of bonds issued in July contained a step-up clause, five times the level of a year ago.
AutoZone Inc., the largest U.S. auto-parts retailer, included both on the $750 million of six- and 10-year notes it sold last month. It was the first time the Memphis, Tenn.-based company has added step-up protection to its bonds, and its first poison put in five years, Bloomberg data show. Autozone's debt is rated Baa2 by Moody's and BBB by S&P.
"We were happy to get it done because it's rocky," Treasurer Brian Campbell says in a telephone interview. "You have to be realistic. It's a tougher market for sellers than it is for buyers."
The difference between what the U.S. government and banks pay to borrow in dollars for three months, known as the TED spread, was at 111 basis points yesterday. That's more than double the 43 basis-point difference of a year ago.
High-yield, high-risk bond sales have shrunk by almost half to $58 billion as investors' appetite slumps. Spreads of about 8.14 percentage points are approaching the five-year high of 8.62 percentage points reached in March, according to the Merrill Lynch High-Yield Master II index. High-yield, or junk, debt is rated below Baa3 at Moody's Investors Service and under BBB-at Standard & Poor's.
In Europe, high-yield companies are all but shut out of the market. There have been no sales of junk bonds greater than 75 million euros ($117 million) by European companies since July last year.
Demand for debt that fueled a record $727 billion of leveraged buyouts dried up, leaving banks with $340 billion of loans and securities they couldn't sell. Companies including Alliance Boots Ltd., the Nottingham, England-based drugstore chain, abandoned plans to issue bonds.
Lutz at Declaration owns no high-yield bonds, compared with a typical allocation of 5%. When he buys, he chooses debt of energy and utility companies as well as makers of consumer goods that aren't hurt as the economy slows.
"While we've been cheering for the credit crisis to end, we haven't had strong enough convictions to commit capital," he says. "I can jump up and down and say, `Oh, it's the cheapest thing in the world,' but unless I actually buy the securities, that doesn't mean anything."