Equity issuance underpins record US corp bond rally

Friday September 25, 2009

By Dena Aubin



NEW YORK, Sept 24 (Reuters) - The fastest pace of U.S. equity issuance in nearly a decade is adding fuel to a corporate bond rally as companies shore up capital, and the trend may have more room to run, analysts say.

Scrambling to unwind leverage after last year's credit panic, nonfinancial U.S. companies issued a net $88 billion in equity in the second quarter, the most since the first quarter of 2000, said Ben Garber, a Moody's Investors Service economist, citing Federal Reserve data.

Nonfinancial corporate debt meanwhile grew at a five-year low of less than 3 percent, Garber said.

The move to raise cash in the stock market while limiting debt growth will likely continue as a sluggish economy keeps companies focused on propping up credit quality, analysts said.

"Companies are still in a hunker down mode," said Keith Springer, president of Capital Financial Advisory Services in Sacramento, California. "There's no top-line sales growth because the consumer is dead, and so companies are over-burdened with debt levels."

BONDHOLDERS REAP BENEFITS

Though Federal Reserve chief Ben Bernanke has said the recession is likely over, most companies are issuing anemic growth forecasts, a sign they expect the recovery to be slow.

"If the economy isn't helping the (financial) numbers get stronger, then companies are going to have to take action to make sure their credit profiles are sustainable," said Kingman Penniman, president of high-yield research firm KDP Investment Advisors. "People want to give themselves some wiggle room."

Share issuance provides an immediate improvement in a corporate balance sheet because it directly lowers a company's debt-to-equity ratio. The less debt a company has relative to its assets, the easier it is to meet interest payments.

Corporate bondholders are benefiting greatly from the change. Year to date, investment returns on corporate bonds are approaching a record 18 percent, compared with a 7 percent loss in 2008, according to Merrill Lynch indexes.

Though equity issuance initially dilutes shareholder value, it may be bullish for stocks in the long run as well, strategists said.

"That's showing you that the company has the right focus, that they're trying to repair the balance sheet," said Peter Andersen, a portfolio manager at Congress Asset Management in Boston.

RATINGS MATTER AGAIN

In another sign of corporate restraint, last quarter was the first time since the second quarter of 2002 that share issuance outpaced share buybacks, according to Moody's. As spending on buybacks fell, cash holdings of nonfinancial companies rose 4.4 percent in the second quarter from a year earlier to $1.6 trillion, a six-quarter high, according to Moody's data.

Companies felt free to add debt before the credit crisis because the cost of rating downgrades was small. Money flooding into the bond market kept borrowing costs down and junk-rated companies were paying little more than higher-rated borrowers to sell debt.

With interest costs low, companies borrowed heavily to pay for share buybacks, sacrificing ratings to boost the value of their shares. Now, with junk bond yields in the double-digits, many companies are trying to get back to investment-grade any way they can, said KDP's Penniman.

"I think the mess we got ourselves into started when the equity people thought if (companies) weren't utilizing leverage they weren't doing what they needed to do to optimize shareholder value," KDP's Penniman said. "I think we're seeing the reverse now."


In September alone, 17 junk-rated companies including AMR Corp, Synovus Financial and Palm Inc raised about $6.3 billion in capital in the equity markets, much of it going to repay debt, according to Bank of America Merrill Lynch data.

Thanks partly to balance sheet repair, rating downgrades are slowing sharply. Moody's downgraded just 31 nonfinancial companies last month, a 71 percent drop from the 106 downgraded in December 2008.

Keith Springer is President of Capital Financial Advisory Services, a registered investment advisor, providing Wealth Management and Mortgage Consulting Services.  For more information on how to build and maintain a solid retirement plan, please contact Keith Springer at 916-925-8900 or Keith@KeithSpringer.com