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Corporate borrowing rates moved higher last week, negative for companies with funding needs

2013.02.06 - Corp Credit YieldsEnlarge GraphCorporate credit yields are a general term for the rate at which companies can issue debt (that is, borrow money). Higher corporate credit yields means more expensive borrowing rates for companies, therefore higher yields are generally negative for companies, especially those with high funding needs which includes many upstream energy producers. Such needs might include expensive capital expenditure (spending and investment) programs, acquisitions, and refinancing of debt coming due.

Last week, corporate credit yields across the quality spectrum increased. One can monitor general corporate credit yields through an index such as the BofA Merrill Lynch Index, which aggregates data from many corporate bonds. The chart below shows the yields on several BofA Merrill Lynch indices of varying credit quality over time.

The chart displays the BofA Merrill Lynch AA Index, BBB Index, and B Index where the letters represent the rating on the bonds issued by companies. The rating system in order of highest to lowest credit quality is shown in the below table. As shown in the above graph, the highest rated index is the AA index, it trades at the lowest yields. That is, bond investors require the least return from AA bonds as compared to BBB and BB rated bonds, as they are perceived to be less risky. For the week ending February 1, the yield on the AA Index increased from 2.09% to 2.14%, the yield on the BBB Index increased from 3.34% to 3.43%, and the yield on the B Index increased from 5.64% to 6.01%.

Moody’s S&P
Aaa AAA
Aa1 AA+
Aa2 AA
Aa3 AA-
A1 A+
A2 A
A3 A-
Baa1 BBB+
Baa2 BBB
Baa3 BBB-
Ba1 BB+
Ba2 BB
Ba3 BB-
B1 B+
B2 B
B3 B-
Caa1 CCC+
Caa2 CCC
Caa3 CCC-
Ca CC

Last week saw a move up in rates, which was a negative for companies. However investors should note that yields on corporate bonds are currently low, especially compared to where they were during the financial crisis. In fact, companies can now borrow at close to or lower than pre-recession interest rates. A large factor behind this is the Federal Reserve’s quantitative easing program, which has pumped money into the financial system and caused investors to bid up the price of assets such as corporate bonds. Despite current low rates, investors should consider monitoring where corporate yields are, as a material move upward in borrowing rates could be a negative for companies. This is especially true for companies which will need to raise money in the debt market and may be forced to do so at higher rate if yields move upward. Companies with planned capital spending above cash flow, for instance, will need to source the cash shortfall somewhere and one option would be to issue bonds in the debt capital markets. Other companies that might need to access the debt markets include companies that are planning to make an acquisition, or companies with bond maturities coming due that need to be refinanced (and likely not enough cash on the balance sheet to simply pay the bond off).

It is impossible to know which companies will be making an acquisition. However, debt maturities are listed in company filings. For instance, Chesapeake Energy (CHK) has $1.4 billion of bonds due February 2015 which it must either refinance with new bonds, or pay off with cash or revolving credit facility. Additionally, some companies may allude to the fact that they will be outspending cash flow. For instance, Range Resources in a December 2012 release regarding its capital spending plans noted, “Range currently plans to fund the 2013 capital budget from operating cash flow, proceeds from asset sales and its available liquidity under the Company’s bank credit facility.” This implies that the capital budget is greater than operating cash flow and outside cash is needed. While Range does not say directly that it will be looking to the bond markets for cash,  companies often issue debt if they have accumulated a significant balance on their credit facility (like a credit card for companies).

Current low rates continue to be a positive for companies across the spectrum. However, last week saw a move up in rates and investors may want to monitor rate movements, especially if they expect that the company will need access to the debt market some time in the near future.