When money is cheap, corporations borrow!
There is always chatter about how money is cheap and big companies can borrow huge amounts at low interest rates. This post will provide insight into how much “cheap money” is really there, who is able to take advantage of it, and how they benefit and put it to use.
When people refer to “cheap money” they are almost always referring to money that’s borrowed as a loan of some type - either from a bank or other financial institution, or directly from market participants in the case of bond issuances.
At a high level the mechanics of these “loans” can be straightforward. There is a principal (amount borrowed), an interest rate (that is paid), and a term (which can be fixed or variable).
The borrower gets the money and is able to use it for their corporate purposes and (hopefully) is able to generate a return greater than the interest rate they pay.
The lender collects interest payments, with return of principal at the end of the loan term.
We are now going to give you a glimpse into what’s been happening in the corporate bond markets in the last 18 months post being hit with COVID-19. Hint: The market is as strong as it’s ever been with yields at generational lows and bond issuances at all time highs!
Recent Corporate Bond Issuances (source: sifma.org)
As we can see corporate bond issuance has EXPLODED post COVID-19. Over $2 Trillion of bonds were issued in 2020 itself, and in 2021 we are on track to exceed that with over $1.2 Trillion already issued thus far.
This was made possible by the actions of the U.S Federal Reserve in response to the COVID-19 pandemic. They took the unprecedented step of basically under-writing the entire corporate bond market, by reducing interest rates to near 0, and starting to buy these bonds on the open market! If you wanted to sell, you always had a willing buyer, the U.S. Federal Reserve, and as we know their supply of funds seems to be unlimited!
Companies that could previously not get a loan anywhere, I’m looking at you Carnival Cruises, are able to raise Billions of dollars at comparatively low rates in the junk bond markets ($2.4Billion for 7 years at 4% in July 2021 source: Bloomberg). Oh, and the best part about these bonds is that they are unsecured! In the past, a lot of the debt that Carnival took on was secured by their cruise liners.
In the investment grade bond market, strong companies like Apple, Oracle & Salesforce are able to raise 10s of Billions with maturities extending out 40 years for just a few percent! Yes, you read that right, 40 years!
Here are the details of Salesforce’s recent $8B bond issue
$1.0 billion of its senior notes due 2024 (3yr) at 0.625%
$1.0 billion of its senior notes due 2028 (7yr) at 1.5%
$1.5 billion of its senior notes due 2031 (10yr) at 1.95%
$1.25 billion of its senior notes due 2041 (20yr) at 2.7%
$2.0 billion of its senior notes due 2051 (30yr) at 2.9%
$1.25 billion of its senior notes due 2061 (40yr) at 3.05%
Source: Salesforce Press Release
Now that’s cheap money! You must be thinking what are they doing with all this money?
Well, Carnival and other companies are using it to fund their day to day operation, as they are presently cash burning enterprises (due to the impact of the pandemic). Salesforce on the other hand is using this money to fund the acquisition of Slack (they are using this for the “cash” portion of the deal). Oracle and other similar companies are using this cheap money to buy back shares, as a way to return capital to shareholders.
All this sounds fine in theory, but the key idea that the bond holders of these companies are counting on is that whatever the companies do with the money, they are able to generate a sufficient return to PAY THE MONEY BACK with INTEREST. Because if that does not happen…
So now that we know that corporate bond issuance is at an all time high, what do we think will happen in the future? With the caveat that the future is hard to predict, we will make a guess that some of the weaker companies will have trouble paying back the money they have borrowed and will likely have to restructure their businesses in order to make bond holders whole.
Additionally, the other risk long term corporate bond holders take on is interest rate risk. So if we see any kind of inflation in the next few years, the folks that bought these bonds at rock bottom rates are going to see their returns suffer hugely. The increase in interest rates that inflation would bring, will reduce the value of these “lower interest” bonds, impacting real returns on capital.
The companies that issued the bonds on the other hand will be rewarded handsomely as they locked in that “cheap money”. They will be the ultimate winners no matter what rates do!
The moral of the story being that it’s always best to borrow money when you don’t need it, and when the economy is flush with cash looking for a place, any place to go!
