Corporate Debt markets are cheap right now

Learn Options trading from Hari Swaminathan from OptionTiger

If you’re a large market-cap investment-grade company in the US, this is about as good a time to hit the corporate debt markets. Interest rates are the lowest they’ve probably ever been, and the spread between Corporate and Treasury debt is also the lowest. This spread represents the additional risk that investors assume to hold Corporate debt as compared to US Government debt. If you recall, during a brief moment in August 2011, when the debt ceiling deadlock resulted in Standard & Poors lowering the US credit rating, a select few corporates like Microsoft (MSFT) were actually yielding less than Treasuries. Investors were suggesting that MSFT was less of a risk than the US Government πŸ™‚

 

 

 

Wall Street Journal has an article on investment grade corporations like UPS, GE and 164 other companies that have sold $92B of 30-year bonds. This number is already the largest amount issued and exceeds 2011 ($73B) by 26%. And we still have almost 3 months to go. Several companies have refinanced debt coming due in 2013 and 2014 and converted them into 30-year bonds. Its much like converting your ill-conceived 5-year ARM home mortgage to a more stable and manageable 30-year fixed mortgage. Makes sense on many levels, but are there some worrying facts underlying this development ?

 

1) Β Hey, the money is cheap, so why not ? Companies are borrowing at the cheapest levels in 25 years. Investment grade companies paid close to 8% in the 90’s as well as during the crisis of 2008 (WSJ Chart). Today, UPS issues 30-year bonds at 3.62%, and the demand for these bonds were 7 times the actual number issued.. The Fed is loose with its monetary policy, and although consumers are not seeing much benefit from these policies, corporates certainly are. No CFO that wants to keep his job would not take advantage of such credit market conditions, and rope in cheap funding for a long, long time.

 

2) Even companies like GE have jumped on the bandwagon, and raised money from the debt market for the first time in 5 years. (GE subsidiary GE Capital regularly taps into credit markets, but its business is financing, so this is understandable). Comcast issued $1B worth of 30-year bonds at 4.45% compared with 7% it sold in past years.

 

3) There is amazing demand for these corporate bonds, as the UPS example shows. And the low spread between investment grade corporates and Treasuries suggest that these corporates are not very risky investments. This demand makes these bonds pricey, and investors are paying a high price to buy these bonds. When interest rates start to rise, these bonds will fall in value (inverse relationship between Bond prices and Interest rates). Either investors don’t believe interest rates will rise anytime soon (which the Fed has signaled anyway), or they’re willing to hold their bonds till maturity. Or are they moving into these bonds out of fear in the equity markets or the general state of the economy in the future.

 

There is no doubt this is great for the companies that issue these bonds – they can lock in long term financing on very favorable terms. But why are bond funds rushing to buy them ? That’s cause for worry – bond experts, kindly weigh in..

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