When Tyco International Ltd. needed to raise capital earlier this year to avoid a looming cash crunch, the conglomerate considered just one option. With rock-bottom interest rates and near-zero investor appetite for new stock offerings, Tyco went to the bond market and issued more debt.
"Our backs were against the wall, and we really didn't have much choice," a company executive said. Despite continued questions about the firm's accounting and governance practices, Tyco, which already had $24 billion of debt, found a receptive market.
Tyco easily sold $4.5 billion -- $1.25 billion more than it originally registered to sell -- in convertible bonds, which pay a set interest rate and can be converted to Tyco common stock. A 20-year issue carried an interest rate of 3.125 percent, and a 15-year bond had an interest rate of 2.75 percent, figures that analysts called remarkably low for a firm as troubled as Tyco.
Hundreds of other companies also have chosen in recent months to capitalize on low interest rates and investors' desire for an investment that is at least perceived to be less volatile than stocks. That has enabled companies to refinance existing debt, lowering their interest costs, and to raise ample amounts of money, despite the weak economy and stock market slump.
In the absence of initial public offerings of stock "and with the downturn in the equity market, firms have increasingly embraced bonds," said Richard Peterson of the market data firm Thomson Financial. "And with rates so low, companies are racing in to take advantage."
Racing may be an apt word. Corporate finance strategists on Wall Street say the market could turn, with the government piling up more debt to finance the war in Iraq. The concern is that increased government borrowing will crowd the debt market and begin driving up interest rates, making it more expensive for companies to borrow.
"A lot of people saw this conflict on the horizon, knew they had funding to do and worked pretty hard to accelerate that funding in front of the conflict," said Chris Whitman, co-head of debt capital markets for North America at Deutsche Bank Securities.
In addition, if the war ends quickly and successfully and the economy begins to improve, investors may start yanking money out of bonds -- essentially publicly traded loans -- to put into stocks. That would boost yields, which move in the opposite direction of bond prices, raising the cost for companies that want to issue bonds.
"At some point investors are going to look at a 1 percent return after inflation and taxes and decide that's not adequate and that they might do better in stocks," Whitman said.
But the high level of debt creates another potential problem. If the economy -- instead of improving after the war -- slips into a recession, companies may well have difficulty paying off the debt.
Investors have not focused on the repayment risk involved in corporate debt and continue to siphon cash out of stocks to put into bonds. According to market research firm AMG Data Services, money has flowed into taxable-bond mutual funds at a rate of $4.7 billion a week over the last four weeks, the heaviest shift on record. February was the biggest month for moving into debt funds ever, with $16.8 billion flowing into corporate bond funds and government funds that invest in mortgage-backed securities. Equity funds, meanwhile, experienced record outflows of $10 billion in February, according to AMG.
According to the Bond Market Association, U.S. companies have issued $185 billion in debt so far this year, up from $174 billion in the same period last year. Last week was the busiest in the high-yield, or "junk," bond market since mid-December, with a dozen firms whose credit ratings were below investment grade selling debt.
James C. Cusser, senior bond trader at Waddell & Reed in Kansas, said that the pace appears to be cooling somewhat but that the lure of easy money will keep companies coming for now. "To put it in perspective, high-quality companies can now issue five-year bonds at lower rates than people are paying for mortgages," Cusser said. Average 30-year mortgage rates fell this month to 5.61 percent.
"That is very cheap money," Cusser said.
Indeed, while the ups and downs of the Dow Jones industrial average and other stock market indexes get most of the media attention, much more money trades hands in the bond market every day. According to the Bond Market Association, the average daily cash value of bond trades in 2002 was $635 billion, more than nine times the $70 billion cash value of daily trades on the New York Stock Exchange, the Nasdaq Stock Market and the American Stock Exchange.
The overall value of the bond market -- which operates over phone lines between brokers and traders instead of on a physical trading floor -- dwarfs the stock market as well. At the end of 2002, the bond market had a total capitalization of $20.2 trillion, slightly less than twice as much as the total stock market capitalization of $11 trillion.
Because of the immense size of the bond market, federal regulators have focused special attention on preventing a disruption of trading in the event of new terrorist strikes. The Treasury Department made a point last week of reassuring investors that it had worked with bond market participants to ensure that lines of communication would stay open and debt sales would continue. Major firms in the bond brokerage business, an area dominated by large Wall Street companies, have also scheduled a series of phone calls to take place if there is an attack so the firms can assess their ability to continue trading.
Meanwhile, bond-market watchers are increasingly worried about the public's voracious appetite for debt. Gimme Credit, a research firm that caters to institutional clients, has been warning investors that corporate America is overleveraged. This comes at a time when credit-rating agencies are more likely than ever to issue downgrades when they see possible credit crises approaching.
Rating agencies came under heavy criticism for not seeing credit problems developing at Enron Corp. and other firms that later filed for bankruptcy.
Downgrades themselves can spark credit problems, however, as they increase interest rates that companies must pay on debt. In some cases, downgrades can tip firms into bankruptcy, and bond holders can suffer, getting back only a fraction of their investment when a company restructures under court protection.