Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

Debt investors have enabled top-rated companies to sell a staggering amount of debt to start 2017.

They've quickly absorbed the record $125 billion of investment-grade bonds issued so far this year. Not only that, but they're also pricing in a lower potential risk of the borrowers being unable to repay them.

Bond Bonanza
U.S. investment-grade companies are selling debt at the fastest pace ever to start a year
Source: Bloomberg

This is especially remarkable because these corporations have been on an almost decade-long borrowing binge. And it doesn't entirely make sense for bondholders, especially considering that one of the most popular uses for this borrowed money has been buying back stock.

This is basically taking money from debt buyers to pad the pockets of equity holders. It has no obvious benefit to the company's long-term prospects; in fact, quite the opposite. As Fitch Ratings said in a report on Thursday, "leveraged share buybacks and other shareholder friendly actions are an ongoing risk to bondholders as borrowing costs remain historically low."

Corporations are mostly borrowing now to take advantage of cheap money, with yields still far below long-term averages. They don’t have to designate a use for the money and often just offer up a vague, catch-all explanation that it's for "general corporate purposes." That means they can use it for pretty much whatever they want.

Cheap Money
U.S. corporate-bond yields are still historically low in the wake of the Fed's unprecedented stimulus
Source: Bloomberg Barclays index data

One of the chief ways appears to be stock buybacks. The Fitch analysts note that one measure of this surged recently to the highest levels since 2014.

Reading Tea Leaves
A measure of how much debt companies use to buy back shares has been at high levels
Source: Fitch Ratings

So will this continue this year? Well, last year was a record year for such repurchases, and 2017 is expected be more of the same.

"We forecast corporations will purchase $800 billion of U.S. equities in 2017 through share buybacks" net of issuance, Goldman Sachs analysts wrote in a Jan. 4 report. That's up from $644 billion in 2016 and $561 billion the year before, the bank's data show.

Getting Equity
U.S. corporate stock buybacks have surged and are expected to set a record this year
Source: Goldman Sachs

Analysts have high expectations for this year's share buybacks in large part because of the change in the U.S. government. The officials who are taking control are expected to ease corporate taxes, prompting companies to bring back money that's stashed overseas to avoid the current levies. Much of this money may go to repurchasing shares.

But the tax code hasn't changed yet, and until it does, companies will most likely continue to use borrowed money for share buybacks. This trend is potentially harmful for bond investors.

Fitch said it had downgraded two U.S. corporations as a result of aggressive share repurchases, Brown-Forman Corp. and Brinker International Inc. It's not a stretch to think that other companies will face a similar fate.

While bond investors have incredibly high hopes for American companies, it would be wise for them to take a closer look at these borrowers' balance sheets. Perhaps it would be worth demanding a little more yield if all a company plans to do is pay off shareholders.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net