Money Market Dysfunction Helps Fuel Corporate Bond BonanzaBy
Borrowing costs for some issuers have reached seven-year highs
Total sales for U.S. corporates on track to beat 2015’s record
U.S. companies feeling pain in short-term debt markets are seeking relief by borrowing longer term, pushing already-high levels of corporate bond issuance toward fresh records.
Google parent Alphabet Inc. and food processor Archer-Daniels-Midland Co. are among the companies that have sold more than $5 billion of corporate bonds in the past two months to pay off at least part of their short-term debt known as commercial paper. They’re looking to tame their interest expenses after new regulations have lifted some issuers’ borrowing costs for near-term debt to seven-year highs.
The changes underscore how money-market rules that take effect in October are distorting debt markets. Total sales for corporate bonds maturing in more than eighteen months are around $950 billion this year, above levels for this time in 2015 and on track to beat the full-year record of about $1.3 trillion, according to data compiled by Bloomberg. Commercial-paper markets, where debt typically matures in 270 days or less, have shrunk by $108 billion since May, according to Federal Reserve data.
“It’s very smart for some of these companies to try to seek other forms of funding if they can because rates in the commercial-paper market are probably going to be moving higher in the near term,” said Mark Cabana, head of U.S. short rates strategy at Bank of America Corp.
The new rules that are pushing short-term corporate borrowing rates higher are designed to make money markets safer after a major fund went under during the financial crisis, triggering a run that the government had to halt. The regulations apply to prime funds that invest in the $1 trillion commercial paper market, and force investors to bear losses when the market value of that debt declines, among other changes.
Banks, the biggest issuers of both short- and long-term debt, may be actively refinancing their commercial paper, wrote strategists led by Priya Misra at Toronto-Dominion Bank unit TD Securities in a note this month. Since the first quarter, banks in the U.S., U.K., Japan and Canada have stepped up sales of U.S. dollar bonds maturing in less than three years in what is probably a move to replace shorter-term funding before October, the strategists said.
Rates on AA rated financial companies’ three-month commercial paper reached 0.9 percentage point this month, the highest since 2009. Average yields on long-term bonds issued by banks, however, are near the lowest in a year, according to Bank of America Merrill Lynch index data.
As fewer investors show interest in buying funds that invest in commercial paper, companies have had to pay more to borrow in that market. Before the new rules were announced in July 2014, top-rated companies paid an average of 0.18 percent to borrow for 90 days. Now, the price has ballooned to 0.83 percent, according to Bloomberg data.
The higher costs weigh on all kinds of companies. While banks are responsible for about half the issuance in the commercial-paper market, the the funding is also used by some of the world’s largest corporations, including Apple Inc., Johnson & Johnson, and Exxon Mobil Corp., often for day-to-day expenses like payroll.
“These issuers who have basically been issuing into infinite demand for decades are now realizing they have to reprice,” said Jerome Schneider, head of short-term portfolio management at Pacific Investment Management Co., which oversees more than $1.5 trillion.
While commercial-paper rates have risen, they’re still far from post-financial crisis highs, which some treasurers say makes them unlikely to cut their short-term funding programs now.
“On a historical basis, it’s still an attractive funding source,” said Nicholas Bijur, vice president and treasurer of utility holding company PG&E Corp. “We’ve definitely seen our rates increase, but I would say we’re not backing away from the commercial-paper market because of that.”
Kimberly-Clark Corp., the consumer products company that makes Kleenex and Huggies, is another company that’s sold bonds in part to take out commercial paper. In July, it paid an average rate of 0.41 percent on short-term debt, according to a company filing. Its interest on 30-year bonds it sold last month is 3.2 percent, its lowest-ever rate for bonds of that maturity, according to Bloomberg data.
The gap between yields on 2-year and 30-year Treasuries reached its narrowest level in more than eight years, meaning that for many borrowers the extra cost of borrowing for say, 30 years is relatively low.
“You can refinance pretty attractively now,” said Chris Brechbuhler, a money manager at Clearwater Advisors, which manages short- and long-term debt.