A recent in-depth study by Merrill Lynch concerning corporate financing during 1985 revealed a great deal of information. First, the volume of new corporate debt -- $102.2 billion -- established a record. The 1985 volume is an increase of 61 percent over 1984's record of $63.3 billion, and a 109 percent increase over the 1983 new-issue volume of $48.8 billion.
The reasons for this outpouring of new corporate debt are several. Interest rates fell dramatically in 1985, especially during the second half of the year. At this point in the business and interest-rate cycle, corporations undertake the restructuring of their balance sheets by refinancing both the debt they incurred when interest rates were much higher, and also by extending their short-term debt with longer term maturities. Consequently, long-term debt accounted for $76.8 billion, or 75 percent, of the total financings. And as the main part of the interest-rate decline occurred during the second half of 1985, 60 percent of the new debt was marketed during the last six months.
Other factors causing the huge volume were several large leveraged buyouts, plus the sizzling pace of mergers and acquisitions. With regard to this type of financing, low quality, or "junk bonds" (BB or lower quality), were utilized. During 1985, $15.3 billion of new-issue junk bonds were sold, down from the $17 billion used in 1984. The damaging aspect of these "takeover" types of corporate financings is that the surviving companies often became saddled (or leveraged) with a heavy debt structure that could prove too difficult to service during a period of economic downturn. Consequently, because of the extreme use of debt in their overall capitalization, several companies that originally enjoyed good credit ratings were downgraded. For example, Baxter Travenol's takeover of American Hospital Supply knocked both of their credit ratings from the AA level to the BBB+ level.
Interestingly enough, high-grade (AAA) issues totaled $27 billion, of which $17.9 billion was comprised of mortgage-backed paper. Issues rated AAA to A accounted for $73.2 billion, or 72 percent, of the new-issue volume. The return to lower interest rates and more stable markets allowed the issuers to de-emphasize special types of issues -- floaters, extendables, put bonds -- that had been created to sell bonds when interest rates were much higher during 1981 and 1982. Only 5 percent of the total were these "tutti-frutti bonds."
The Treasury will offer its quarterly refunding this week with the sale of three issues. They include a three-year note on Tuesday, in minimum denominations of $5,000; a 10-year note on Wednesday, in $1,000 minimums; and a 30-year bond on Thursday, also in $1,000 minimums. They should return 8.15 percent, 9.05 percent and 9.30 percent, respectively.
Investors may subscribe to these issues by going to the Federal Reserve Banks or their branches, and to the Bureau of the Public Debt (1300 C St. NW). Banks and brokerage houses will also enter a subscription for these securities, but a fee will be charged.