Thursday, July 29, 2010

Bonds Soar to Rare Heights

Corporate Borrowers Feast on Cheap Debt; McDonald's to Pay Record Low Interest


The global corporate-bond boom is gathering steam as companies rush to take advantage of some of the lowest borrowing costs in history.

Companies from global giants McDonald's Corp. and Kimberly-Clark Corp. to Indonesian telecommunications company PT Indosat Tbk are rushing to sell debt.

This month has been the busiest July on record for sales by U.S. companies with junk-credit ratings. Asia's debt market is on pace for a record year, and European companies are also raising money apace.

The low borrowing costs are the culmination of an unprecedented bond-market rally that began in the depths of the credit crisis in late 2008 and early 2009 and has defied every prediction that it would soon run out of steam. But individual and professional investors continue to plow money into the bond market, giving companies a constant source of funds to tap.

With each new leg higher, the bond market gets more expensive and interest rates, which move in the opposite direction of price, fall even lower. If the economy heats up and rates rise, investors gobbling up bonds will get burned as bond prices fall.

But for now, many of the conditions that got bonds rolling in the first place still hold sway. The Federal Reserve has short-term interest rates near zero, investors are leery of stocks, and the economic outlook is too sluggish to spark a robust stock boom but not so bad that it causes companies to default.

Companies big and small are taking advantage of the low rates to bolster their balance sheets and lower their interest costs by millions of dollars for years to come. "I think we are accessing the market at precisely the right time, and a very opportune time," said Stephen De May, treasurer of Duke Energy Indiana, whose subsidiary in early July borrowed $500 million at 3.75%, the fourth-lowest rate on record for a large U.S. corporate borrower, according to Bank of America Merrill Lynch.
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McDonald's this week raised $450 million in 10-year debt at 3.5%, a record low yield for a large batch of debt issued by a U.S. corporate borrower. The U.S. government paid more than 3.5% for its 10-year debt as recently as May.

The financial sector has been the busiest player in the bond market so far this year, as it was last year, raising about 48% of total debt issuance globally. Financial firms are paying higher borrowing costs than companies like McDonald's, but their rates are still historically cheap. J.P. Morgan Chase just issued $2.5 billion in 10-year debt at 4.4%.

Interest rates on investment-grade corporate bonds recently averaged just 4%, according to Barclays Capital, the lowest in more than six years, and just 1.7 percentage points above relatively risk-free Treasury debt.

Lower borrowing costs are a boon to corporate profits, which could in turn benefit the broader economy and hiring. Duke Energy Indiana used its debt proceeds to fund power plant construction among other things.

But many companies are simply borrowing to refinance old debt. And many are leaving the cash haul on their balance sheets, bracing for the possibility of fresh crises or leaner growth ahead. That suggests the economic benefit of the borrowing boom could be limited.

"They're not looking to invest or to take on assets to try and build their business," said Justin D'Ercole, head of Americas Investment Grade Syndicate at Barclays Capital, who helps companies sell new debt.

Corporate bond sales around the world so far have reached about $1.4 trillion this year, lagging behind the record $2.1 trillion for the same period in 2009, according to data provider Dealogic. But offerings were largely put on hold during May and part of June as the sovereign-debt crisis grew in Europe.

As more and more investors pour money into the bond markets—helping fuel the debt sale bonanza—the risks increase they are just hopping on the latest bubble. Observers question whether the bond market can continue to generate such returns and wonder if investors are paying too dearly for corporate bonds that still have risks. "I looked at McDonald's debt and felt marginally the same as if I'd eaten five Big Macs in a row," said Jason Brady, portfolio manager at Thornburg Investment Management in Santa Fe. "It's a great company, but I don't need to own a low-A-rated corporate risk at 3.5%."

Bond investors have enjoyed healthy returns from corporate debt so far. Investment-grade bond returns, which include both the money given back to investors in the form of price increases and regular coupon payments, are up nearly 8% this year. In contrast, stock returns have been slightly negative.

For now, investors seem willing to finance companies at ever-lower rates. And analysts say a large number of companies are waiting in the wings to raise money. "There is a big calendar building," said Steven Miller, the head of Leveraged Commentary and Data group at Standard & Poor's. Many U.S. companies are waiting until after the Labor Day, the unofficial end to the U.S. summer. "If the market stays strong, we will see a burst of issuance," he said.
—Neil Shah contributed to this article.

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