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Businesses Are Supposed to Cut Debt in a Downturn. Why Not Now?

Since the 2008 global financial crisis, American corporations have taken advantage of historically low interest rates to gorge themselves on debt. Then came the pandemic and the sharpest economic downturn in history, which resulted in an odd solution for the companies that did all that borrowing: more debt.

Through late June, giant U.S. companies had borrowed roughly $850 billion in the bond markets this year, double the pace from last year. Analysts at JPMorgan Chase anticipate that investment-grade companies will borrow roughly $1.6 trillion from investors by the time 2020 is over.

It has turned conventional wisdom on its head.

“During a standard recession, and that would include the global financial crisis as well, you would expect to see corporate debt as a percentage of G.D.P. begin to come down,” said Paul Ashworth, chief U.S. economist at Capital Economics, a consulting firm.

The increased borrowing can be traced, in part, to the actions of the Federal Reserve. The central bank slashed interest rates back to rock-bottom levels, making it attractive for businesses to refinance and borrow more to build a cushion of cash. But an even bigger factor was the Fed’s announcement — in the heat of March’s market upheaval — that it would buy corporate bonds.

Investors have been so emboldened by the Fed’s actions that even companies viewed as especially risky are having no problem borrowing heavily despite a deeply uncertain economic recovery marked by spiking infections and rolled-back reopenings.

“Now they have, like, a second life,” said Steven Chylinski, head of fixed-income trading at Eagle Asset Management in St. Petersburg, Fla.

Heavily indebted companies — with below-investment-grade, or junk, credit ratings — issued a record $48 billion in new bonds in June alone. They included Abercrombie & Fitch and Sirius XM Radio.

Other companies that were shunned by investors a few months ago because of the threat of the virus are likewise finding no shortage of willing lenders. Hotel companies like Marriott and Hilton have borrowed hundreds of millions of dollars, the online travel company Expedia borrowed more than $2.5 billion, and the concert company Live Nation borrowed over $1 billion.

Long-term strategy has effectively gone out the window, on both sides: Some investors feel free to ignore the risks of lending to companies that are focused on surviving the crisis and figuring the rest out later.

“Do they have a viable business going forward? Maybe or maybe not,” Mr. Chylinski said. “But if they didn’t have this Fed facility and the confidence that the Fed gave the market, they wouldn’t have been able to come to the market and borrow.”

The borrowing has been a boon for Wall Street, providing a rare bright spot for banks that are setting aside billions of dollars in case consumers and corporations become unable to cover their debts. Banks collect hefty fees for squiring these bonds to market, and quarterly earnings reports last week showed remarkable increases in investment banking revenue over a year earlier, including 91 percent at JPMorgan Chase. Citigroup said its underwriting business for investment-grade bonds was up 131 percent from the same time last year. Goldman Sachs reported record numbers for debt underwriting, “reflecting a significant increase in industrywide volumes.”

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Corporate debt has been growing steadily since the last financial crisis. Back then, the Fed slashed interest rates to near zero — and kept them there. For the next decade, there was little reason not to pile up debt: Stocks climbed ever higher, and corporate earnings more than made up for the borrowing, even as rates began to creep up. Since 2008, corporate debt held by nonfinancial companies has increased 92 percent, to nearly $6.8 trillion. (Financial firms aren’t considered because they typically borrow money to relend it, which could result in a kind of double counting.)

The pandemic’s blindside hit immediately changed the way investors looked at that pile of debt.

Bondholders sprinted to sell, fearing that even the most bulletproof companies wouldn’t be able to pay their debts. Benchmark corporate bond indexes plummeted about 5 percent in a matter of days in one of the sharpest drops in the market’s recent history.

It threatened to set off a full-blown crisis. Bond yields, which move in the opposite direction of prices, soared. Those yields are used to calculate the cost of new borrowing, such as the short-term loans that companies use to pay for basics like payroll and inventories. There was a danger that many companies — even those feeling no ill effects from the virus — wouldn’t be able to pay their bills.

The Fed took drastic measures to break the doom loop. On March 15, in a highly unusual Sunday announcement, the central bank cut interest rates to near zero. After another terrible week — the worst for stocks since the 2008 financial crisis — the Fed said it would buy corporate bonds for the first time in its history.

That seemed to do the trick. Within days, the government’s unlimited buying power virtually eliminated the panic.

“There’s the feeling there that, even if we were to have another big sell-off, the Fed would step in and do more if they have to,” Mr. Chylinski said.

Surging bond prices have pushed yields down sharply. By some measures, they’re hovering at some of lowest levels on record, meaning it has never been cheaper for companies to borrow.

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At first, only the bluest of blue-chip corporations were able to open investors’ wallets. Nike borrowed $6 billion. The energy subsidiary of Warren E. Buffett’s Berkshire Hathaway borrowed $2 billion. McDonald’s, Deere and Pfizer loaded up on billions more.

But the trickle became a flood, as investment-grade companies borrowed record amounts in March, April and May, when they issued more than $230 billion in debt, according to Dealogic.

Soon even the riskiest borrowers were again welcome in the market, which some critics argue might be a problem with the Fed’s approach.

The low costs of borrowing will inevitably keep some companies alive that would otherwise have gone bankrupt this year, creating a class of so-called zombie companies that stagger along but are too weak to invest and grow while sucking up cash that could be put to better use elsewhere. After Japan’s economic crash in the early 1990s, such companies were long seen as a contributor to the country’s economic stagnation.

But most market analysts say visions of American corporate zombies are far less frightening than the economic cataclysm the country was facing back in March.

And for now, the Fed’s actions have transformed the fear that racked investors into opportunity — perhaps bordering on greed — as they race to buy riskier bonds with higher payoffs.

Daniel Krieter of BMO Capital Markets called this a “yield grab” trading environment. Investors are clamoring for big returns, and the pieces are in place to support it.

“There’s demand for all this kind of debt out there,” he said.

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