News Analysis September 27, 2009, 7:50PM EST

The Rush to Refinance Corporate Debt

Companies with obligations that mature by 2012 are issuing a flood of new bonds. Does this betoken pessimism about recovery or wise management?

Story Tools

Ka-ching. That's the sound of cash flowing into U.S. companies amid a deluge of new debt offerings this year, now on pace to surpass last year's total. As of Sept. 23, $666.44 billion of investment-grade and high-yield debt had been issued year-to-date, compared with $503.78 billion in the first nine months of 2008 and $673 billion for all of last year, according to data released by Dealogic on Sept. 24.

This may come as a surprise a mere six months after the height of the worst liquidity crisis in the history of global capital markets. But consider this: Whereas the proceeds from past debt issuance went toward general corporate purposes and long-term growth initiatives, 80% of these proceeds will be used to take out or substantially pay down debt that's slated to mature over the next few years.

Announcements of new debt issuance are now "often accompanied by the announcement for a tender [offer to existing debt holders] for outstanding debt at a pace I have never seen in past years," says Tom Murphy, manager of the RiverSource Diversified Bond Fund (RDBIX). He sees the breakneck pace at which new bonds are being issued in order to retire near-term maturities as a sign that corporate managers are worried the credit markets may tighten up again. It also tells him they're less optimistic about the prospects for economic recovery than are most economists and bulls—and are girding themselves for the possibility of further pain ahead.

"Corporate America…went through a near-death experience," he says. "There were literally days and weeks in the fall [of 2008] and spring where the highest-quality companies didn't have access to refinancing commercial paper or bank debt. A lot of them have vowed they don't want to be in that situation again."

Near-Term Debt: More Than $1 Trillion

Other bond managers, however, view the issuance of new debt as a wise move in recognition of how low total borrowing costs are. "Smart companies are out there securing financing when they can, just to remove any risk that they'll be forced into default by a liquidity or maturity issue," says Michael McGonigle, director of investment-grade research at T. Rowe Price Group (TROW) in Baltimore. Other companies, however, are just fighting to survive, "trying to delay the day of potential Armageddon" by pushing out maturities and loosening debt covenants, he adds.

According to a report published in May by the Standard & Poor's Global Fixed Income Research team on the rising costs of issuing all but the highest-rated bonds, $394.7 billion in investment-grade corporate bonds matures in 2010 and another $412.6 billion in 2011, while $162.9 billion of speculative-grade debt must be repaid in 2010 and $265.7 billion in 2011.

A new white paper published on Sept. 24 by Ramirez & Co., a New York-based investment bank, shows that U.S. companies should reduce the debt on their balance sheets by an average 15% to 20% given the shocks to the marketplace, including the decline in production and earnings growth, the rise in unemployment, and the drop in stock prices.

The credit markets look far healthier than they did when S&P released its May report on issuance costs. That bodes well for debt-service costs, which should be coming down as a result of lower coupon rates. Currently the yield for investment-grade debt, as shown by the U.S. Barclays Corporate Investment Grade Index, is 4.94%, roughly 1.5% below the average yield of 6.37% over the past 16 years, says Murphy at RiverSource.

For the most part, companies with debt ratings of BB or below have to issue bonds in the high-yield market, where borrowing costs are much lower than a few months ago because of the dramatic drop in yields. Coupon rates on BB- and B-rated paper are 8% to 10%, vs. 15% to 20% earlier this year.