During the last week of May, treasurers representing America’s bluest chip companies gathered at the Park Hyatt hotel in Philadelphia for a conference dubbed “Survival Skills.”
Instead of discussing ways to take advantage of the drop in borrowing costs to expand their businesses after the Federal Reserve cut interest rates to near zero, representatives of New York-based Colgate-Palmolive Co.,International Business Machines Corp. in Armonk, New York, and dozens of other companies had other plans.
After watching credit dry up almost overnight as the subprime mortgage contagion spread in 2007 and 2008 and Lehman Brothers Holdings Inc. collapsed in September, companies were more preoccupied with stockpiling cash and extending debt maturities by selling a record $301 billion of investment-grade bonds in the first half.
Those events were “fresh in everyone’s memory,” said Brad Fox, chairman of the National Association of Corporate Treasurers and treasurer of Pleasanton, California-based grocery chain Safeway Inc. “We spent a lot of time talking about the aftermath of the fourth quarter.”
Microsoft Corp., the world’s largest software maker, and Pfizer Inc., the maker of the cholesterol fighting drug Lipitor, led at least 262 non-financial borrowers in the first half, the most since at least 2001, according to data compiled by Bloomberg. Bond sales are rising even as the economy struggles to pull itself out of the deepest recession since the 1930s.
‘Precautionary Borrowing’
“There’s still a good deal of precautionary borrowing taking place,” said John Lonski, the chief economist at Moody’s Capital Markets Group in New York, a unit of Moody’s Investors Service. “There are a number of unresolved issues regarding access to capital.”
The $3.75 billion sale May 11 by Redmond, Washington-based Microsoft was its first ever and was done even though regulatory filings show the maker of Windows computer operating systems had $25.3 billion in cash and short-term investments as of March 31.
“It’s always better to issue when you don’t have to,” said Microsoft TreasurerGeorge Zinn. “Microsoft has been evolving its capital structure over a long period of time. This is just part of that logical evolution.”
While treasurers are anxious, signs the worst of the recession may be over is spurring demand for corporate bonds. U.S. investment-grade company debt returned 9.2 percent in the first half of the year, outperforming Treasuries by 13.7 percentage points, the most on record, according to Merrill Lynch & Co. index data.
Beating Stocks
They also did better than the Standard & Poor’s 500 Index of stocks, marking the first time since 2002 that the fixed- income securities outshined both Treasuries and equities. The gains this year in investment-grade corporate bonds compare with the loss of 6.82 percent last year. High-yield, high-risk, or junk, bonds returned 29 percent, after losing 26 percent, Merrill Lynch index data show.
“Demand for high-quality credit is still exceeding the supply,” said Mark Kiesel, global head of corporate bonds at Pacific Investment Management Co., which oversees $747 billion from Newport Beach, California. “You can get equity-like returns by owning corporate bonds.”
Consumer spending rose in May as benefits from the Obama administration’s stimulus plan spurred a jump in incomes. The 0.3 percent increase in purchases was the first gain in three months, the Commerce Department said June 26. Incomes climbed 1.4 percent, the most in a year, driving the savings rate to a 15-year high. Another report showed consumer sentiment rose in June to the highest level since February 2008.
Gross domestic product may grow 1.9 percent in 2010 after contracting 2.7 percent in 2009, according to a Bloomberg survey of economists.
Most Since 2001
The number of non-financial companies issuing bonds in the first half was up from 205 last year and was the most since at least 2001, when there were 264, according to Bloomberg data. When including high-yield, high-risk borrowers, sales overall, totaled $744 billion, compared with $590.2 billion in the same period of 2008.
“The broad participation has really advanced throughout the second quarter and we believe that will continue,” said John Cokinos, head of high-yield capital markets at Bank of America Merrill Lynch in New York. “There’s more of a willingness by the investor base to look at challenging names because the spreads have tightened so much.”
While the extra yield investors demand to own investment- grade company debt rather than Treasuries narrowed to 3.31 percentage points from 6.04 percentage points, it’s still almost triple the average for the decade ending in 2007, Merrill Lynch data show. Yields have declined 1.67 percentage points to 6.14 percent on average.
Feldstein’s Trepidation
Martin Feldstein, a member of the private panel that dates the start of recessions and recoveries, said the U.S. economy will grow for a few quarters and then contract again.
“We’re going to see a temporary substantial improvement,” Feldstein, the former head of the National Bureau of Economic Research and a Reagan administration adviser who is now a professor of economics at Harvard University, said in a July 1 interview on Bloomberg Radio. “I emphasize the words temporary and substantial.”
After the economy shrank at a 5.5 percent annual pace in the first quarter of the year, the change in GDP will be “closer to zero” or “even a small plus” for the April-to- June period, Feldstein said.
Reality Check
Optimism about the pace of the recovery was damped July 2, when the Labor Department in Washington said payrolls declined by 467,000 last month following a 322,000 drop in May. The jobless rate rose to 9.5 percent, the highest since August 1983, from 9.4 percent.
Underscoring Feldstein’s concerns, the treasurer’s conference May 27 to May 29 included sessions on “Liquidity Management in Volatile Markets,” according to the program titled “High Profile Treasury: Survival Skills.” The group’s board includes IBM Treasurer Martin Schroeter and Colgate Treasurer Edward Filusch.
“This year we’ve seen a structural shift in the market,” said Mark Bamford, head of global fixed-income syndicate in New York at Barclays Capital, the biggest underwriter of bonds worldwide this year. “We’ve had crises before, but we haven’t had such concerns about the global banking sector as we had over the course of the past year.”
Rising Defaults
While credit spreads are narrowing, defaults continue to rise. The U.S. speculative-grade default rate jumped to 8.1 percent in May, the highest since October 2002, and may reach 14.3 percent in the next 12 months, Standard & Poor’s says.
Yield spreads will likely remain wider than the average of the last 10 years, said David Kelly, the chief market strategist for J.P. Morgan Funds in New York. The unit of JPMorgan Chase & Co. oversees $438 billion.
“There will be a new normal,” Kelly said. “When we have that strong evidence the economy is beginning to recover, we’ll see wider spreads than we saw in the middle of this decade because those numbers themselves were a bit of an aberration.”
There are signs that banks are still wary of lending. Financial institutions arranged $38.4 billion in leveraged, or high-yield, loans in the first half, an 80 percent drop from the same period in 2008, according to Bloomberg data. A record $978.5 billion of leveraged loans were made in 2007 as banks competed to finance the largest buyouts ever.
Use of Proceeds
No longer able to rely on banks for a steady supply of capital, borrowers are selling bonds and using the proceeds to repay short-term debt and loans.
Unsecured commercial paper outstanding plunged 31 percent to $1.15 trillion, the lowest level since September 1998, Fed data show. Proceeds from about 60 percent of high-yield bond sales this year through May were used to pay down bank debt, according to S&P’s LCD. That compares with 17 percent in the same period of 2007.
Las Vegas-based Harrah’s Entertainment Inc., the world’s biggest casino company, sold $1.375 billion of notes in May to repay parts of a $9.18 billion senior secured credit facility used to finance Apollo Management LP and TPG Inc.’s buyout of the company in January 2008, according to a regulatory filing.
On June 17, Terremark Worldwide Inc., a provider of information-technology infrastructure services, sold $420 million of 12 percent senior secured notes due in 2017 in the company’s first bond offering in two years, Bloomberg data show.
‘Nonexistent’ Loans
“Most of the bank market has really been, to some degree, nonexistent or very slow,” said Jose Segrera, the Miami-based company’s CFO. “The market opened up a little bit and we thought for us it was a great avenue to fund.”
New York-based Pfizer, the world’s largest drugmaker sold $13.5 billion of bonds in March to repay bank loans coming due in December that were used to finance its $64.7 billion bid for Madison, New Jersey-based Wyeth.
While the cost of issuing the bonds was about 1 to 2 percentage points higher than it would have been a year earlier in terms of the interest rate, demand from corporate debt investors made it a good time sell the securities, saidFrank D’Amelio, Pfizer’s CFO.
“The permanent financing compared to the bridge financing is economically very sound,” D’Amelio said. “Which is part of why I wanted to do it as quickly as I could, and two, it was clearly a nice market opportunity.”
Anadarko Maturities
Investor demand prompted Anadarko Petroleum Corp. to lengthen maturities on bonds to 30 years, said Robert Gwin, CFO of the company, based in The Woodlands, Texas. The second- largest independent U.S. oil and natural gas producer sold $2 billion in debt this year, Bloomberg data show.
“On an absolute basis, cost of capital is attractive, and on a relative basis, certainty today is better than uncertainty in the future,” Gwin said.
Anadarko increased the size of an offering of 5- and 10- year notes to $900 million from $750 million on June 9 and added a 30-year maturity after requests from investors, Gwin said. “Since there hasn’t been as much long issuance, that’s what we understood drove their interest,” he said. “If you can put some relatively low-cost capital out very, very long, it gives you the ability to earn returns and continue to reinvest that capital without being subject to refinancing risk.”
