Rising rates would be negative for energy companies with funding needs
Corporate 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 funding needs such as Chesapeake Energy (CHK) or Range Resources (RRC). Such needs might include expensive capital expenditure (spending and investment) programs, acquisitions, and refinancing of debt coming due.
One can monitor corporate credit yields through an index such as the BofA Merrill Lynch Index. The chart above shows the yields on several indices over time.
The chart displays the 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 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.
| 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 |
As shown in the graph above, 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. Still, rates are currently at lows, but 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 (RRC) 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, investors may want to monitor the direction of corporate borrowing rates, especially if they expect that the company will need access to the debt market some time in the near future.
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