Companies are taking advantage of the lowest borrowing costs on record to sell debt financing share purchases and acquisitions, signaling bondholder confidence the U.S. will avoid falling into another recession.
MetLife Inc., the largest U.S. life insurer, issued $3 billion of bonds last week to help fund its purchase of an American International Group Inc. unit, while Expedia Inc., the largest Internet travel agency, and insurer Aflac Inc. each sold $750 million of notes that can be used for buybacks, according to data compiled by Bloomberg.
Bond investors are wagering that companies sitting on more than $1.2 trillion have enough cushion to meet interest payments even as the world’s largest economy struggles to regain the 8.4 million jobs lost during the recession that began in December 2007. That’s helping borrowers sell the highest proportion of debt intended to foster growth and reward shareholders since at least 2006, according to data compiled by Moody’s Capital Markets Group and research firm Dealogic.
“Bond investors as well as corporations have basically taken the double-dip scenario off the table and feel relatively secure we’re going to get a little decent revenue, earnings and economic growth in the second half,” said Burt White, who helps oversee about $277 billion as chief investment officer at LPL Financial Corp. in Boston “It’s more of a bullish sign from an investors’ perspective, that folks are not just buying it, they’re gobbling it up.”
Forty-two percent of investment-grade companies that sold new issues in U.S. dollars last quarter cited mergers and acquisitions as a use of proceeds, the highest proportion since at least 2005, Moody’s and Dealogic data show. The proportion of bond sales for refinancing declined to 57 percent from 69 percent in the first quarter, according to the data, which tracks use of proceeds excluding general corporate purposes.
Mergers and acquisitions passed $1 trillion this year globally through July, more than a 10 percent increase over the first seven months of 2009, Bloomberg data show.
Elsewhere in credit markets, the extra yield investors demand to own corporate bonds globally rather than government debt fell for a fifth straight week even as sales soared.
Corporate bond issuance worldwide surged 12.5 percent last week to $61.3 billion, compared with $54.5 billion in the five days ended July 30, Bloomberg data show.
Spreads shrank 2 basis points to 175 basis points, or 1.75 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate index. The gap has declined 26 basis points since June 11. Yields fell to 3.656 percent from 3.722 percent.
In the U.S., yields on investment-grade corporate bonds declined to the lowest in seven years, according to Bank of America Merrill Lynch index data. The average yield fell to 3.942 percent from 4.001 percent on July 30. The yield is the lowest since it reached 3.928 percent on June 24, 2003.
The cost of insuring against losses on corporate bonds in the U.S. and Europe fell. The Markit CDX North America Investment Grade Index Series 14, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, declined 1.34 basis point to a mid-price of 102.8 basis points as of 12:10 p.m. in New York, according to Markit Group Ltd.
The Markit iTraxx Europe Index of 125 companies with investment-grade ratings dropped 0.81 basis point to 102.8, Markit prices show.
The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Investor demand for corporate debt amid record-low Treasury yields has helped companies get some of the cheapest borrowing rates on record. The top 10 lowest-yielding U.S. corporate new issues in history were sold in the past 14 months, Deutsche Bank strategists led by Jim Reid in London wrote in an Aug. 4 note.
MetLife, based in New York, sold $1 billion of 4.75 percent debt due in February 2021 at a spread of 185 basis points, Bloomberg data show. It also sold shares to help fund its $15.5 billion acquisition of AIG’s American Life Insurance Co. Hess Corp., the New York-based oil company, sold $1.25 billion of 5.6 percent bonds due in February 2041 last week to help fund stakes in a pair of Norwegian North Sea offshore fields.
“When people weren’t as sanguine about the future, and I’m thinking more about last year, assets were cheap but you couldn’t get debt financing for them,” said Tom Murphy, a money manager who helps oversee more than $20 billion of investment-grade credit at Columbia Management in Minneapolis. “You probably can’t buy assets as cheap as you could this year but you have a better chance at financing them at better long-term rates in the debt markets.”
Minneapolis-based Target Corp., the second-largest U.S. discount retailer after Wal-Mart Stores Inc., Aflac, the world’s biggest seller of supplemental health insurance, and Union Pacific Corp., the biggest U.S. railroad by 2009 revenue, sold debt this quarter that may be used to fund buybacks.
In its July 28 offering, Omaha, Nebraska-based Union Pacific obtained the lowest coupon for debt of similar maturity since at least the 1950s.
Aflac, based in Columbus, Georgia, sold $300 million of 3.45 percent, 5-year notes that yield 185 basis points more than similar-maturity Treasuries, and $450 million of 6.45 percent, 30-year securities that pay a 240 basis-point spread, Bloomberg data show. Proceeds may be used to repay notes set to mature in September 2011 and to repurchase stock, the company said in an Aug. 4 regulatory filing.
Bellevue, Washington-based Expedia’s $750 million sale of 5.95 percent, 10-year notes on Aug. 2, its biggest offering and lowest coupon debt, was boosted from $500 million on “excessive demand,” said Chief Financial Officer Michael Adler.
“We watched the market very closely and given Treasury yields and tightness in spreads we found it to be a very opportunistic time to raise some money,” he said in a telephone interview last week.
Seven percent of companies sold debt for buybacks in the second quarter, matching the proportion in the previous three months, which was the fastest since the fourth quarter of 2006, according to the Moody’s and Dealogic data.
“This is a step in the right direction for those yearning for a return to normalcy in the capital markets,” said John Lonski, chief economist at Moody’s Capital Markets in New York.
Stocks are cheaper than bonds as measured by the difference between the dividend yield on equities and investment-grade corporate debt. The gap is near the smallest in at least two decades, data compiled by Bloomberg and Barclays Capital show.
Company bonds yield an average of 3.92 percentage points as of Aug. 5, Barclays data show. That’s 1.95 percentage points more than the cost to pay dividends for companies in the S&P 500. The narrowest gap was 1.93 percentage points on July 30.
The dividend bond-yield gap averaged 2.42 percent this year. The last time it was below 3 percentage points was in 2004, right before companies began a record amount of buybacks over the following three years.
U.S. corporate bonds have returned 8.8 percent this year, including reinvested interest, compared with the 1.76 percent for the S&P 500 Index.
As companies shift attention to equity holders, bond investors face a credit risk that may come into play by the end of the year, said Leslie Barbi, a fixed-income managing director at Guardian Life Insurance Co. of America, who helps oversee $23 billion in fixed-income assets.
“We’ve been in kind of an ideal world for corporate credit recently, meaning, if people are nervous, they’re not going ahead with buybacks and mergers and acquisitions,” she said. “That’s out there on the risk front for corporates, that if everything seems right again with the economy, you do get to the point where companies tend to focus more on the equity holders.”