For corporate financial executives, the recent decline in interest rates has been a mixed blessing. Sure, the rates for their short-term notes and commercial paper have been cut to the bone. But long- and medium-term bonds have given ground grudgingly, causing the "yield curve"--the spread between long and short rates--to widen tremendously, to more than 4 percentage points between three-month Treasury bills and 30-year Treasury bonds. But if you think companies are shying away from long- and medium-term bonds, in favor of shorter maturities, guess again.
Dozens of major companies, from American Telephone & Telegraph Co. to Westinghouse Electric Corp., are coming to the credit markets with long- and medium-term as well as short-term issues, despite the steepness of the yield curve (table). Corporations are, in effect, betting with their balance sheets that interest rates are bottoming out across the spectrum. "Last week there was $10 billion in corporate financing--that's more than we used to see all year not too long ago," marvels Edward Z. Emmer, executive managing director for corporate finance at Standard & Poor's Corp.
The hot-and-heavy activity in the credit arena contrasts with the equity markets. The once sizzling market for initial public offerings and secondary stock offerings, which was propelled by the bull market in 1991, has subsided as stocks have seesawed in recent months. But the bond market is exploding as rates have declined across the board. The biggest declines have come in the shortest maturities, with three-month Treasury bills yielding 3.3% and similarly short-term commercial paper fetching 3.4%. Meanwhile, 30-year Treasury bonds are now yielding 7.7%. By contrast, a year ago three-month bills yielded 5.7% and 30-year bonds yielded 8.5%.
Even though longer-term rates have come down less than a percentage point, the market has seen a flood of fixed-income offerings with durations of a decade and more. The issuers include a cross-section of major industrial companies, in addition to the banks, insurance companies, and financial subsidiaries that traditionally dominate the capital markets. "Rates are historically attractive," observes Jack M. Greenberg, chief financial officer of McDonald's Corp., which recently issued $150 million in 10-year notes yielding 7 3/8%.
RIGHT PRICE. Like many other companies, McDonald's is going to the debt market to replenish its corporate coffers because the price is right--or as the prospectuses say, for "general corporate purposes." In McDonald's case, the company's strong cash flow has been stretched thin by ferocious expansion internationally. But a more common rationale among bond issuers has been to retire existing debt. That, along with "general corporate purposes," was the motivation for one of the largest such recent issues, from AT&T. On July 15, it issued $500 million in debentures at a rate of 8 1/8%, maturing in 2024--32 years in the future.
AT&T's foray into long-term borrowing is an illustration of how declining short-term rates can sometimes make it smart for companies to issue long-term debt. Much of its $500 million issue will be used to redeem $188 million in 25-year notes that were sold in 1972. Those notes were paying just 7 3/4%-- 3/8 of a percentage point less than the 8 1/8% debentures that replaced them.
Why pay 8 1/8% to replace debt that had paid 7 3/4%? For AT&T, the issues involved were not so simple. The first question the company had to answer was whether to redeem the bonds at all--"an entirely separate issue from what to replace them with," notes Peter Sperling, AT&T's director of corporate finance. Since those 1972 notes had five years to run, and comparable five-year notes could now be sold with a yield of 6 3/4%, it made sense to redeem the notes.
But Sperling says that issuing five-year notes would run afoul of AT&T's wish to lengthen the maturities of its debt, and the company felt that 8 1/8% is cheap for a 32-year loan. "Industrial companies can't match the life of their assets and the life of their liabilities as precisely as financial companies, but we try," notes Sperling. And with long-term debt clogging the market, long rates will have to remain high to attract investors--and the yield curve will remain as steep as the Matterhorn.
HOW SOME COMPANIES ARE LOCKING IN LOWER RATES Issuer Amount Rate Term Millions Years AT&T $500 8 1/8% 32 BELL TELEPHONE Penn. 150 7 3/8 15 WESTINGHOUSE ELECTRIC 350 8 3/8 10 McDONALD'S 150 7 3/8 10 SHELL OIL 250 6 5/8 7 DILLARD DEPT. STORES 100 7 3/8 7 WASTE MANAGEMENT 250 6 3/8 5 MASCO 200 6 1/4 3 PEPSICO 200 5 5/8 3 DATA: STANDARD & POOR'S CORP; BW