Like millions of American homeowners who have been refinancing their mortgages, corporations have been taking advantage of the lowest interest rates in decades.
They have been lowering their interest costs, or exchanging short-term debt for inexpensive long-term money, to improve their balance sheets and boost their profits. Analysts said this is one of the key channels through which the Federal Reserve's policy of pegging overnight interest rates at an extremely low 1.25 percent is helping the sluggish U.S. economy.
Financial giant J.P. Morgan Chase & Co., for instance, was able to raise $500 million by selling five-year notes Thursday at only 3.625 percent, the lowest level in the bank's history. And XTO Energy Inc. found great demand Thursday for a $400 million issue of 10-year notes that it will use to buy gas-producing properties in the West.
Thus, some analysts say that if economic growth begins to accelerate, as many forecasters expect it will later this year, firms will be in a better position to finance new capital investments.
Investors have been snapping up the new corporate notes and bonds because interest rates on the traditional no-risk investment, U.S. Treasuries, have dropped so low that even the slightly higher yields on corporate debt seem attractive. In addition, corporate bonds are looking safer to investors as confidence in the corporate financial condition rebounds from the worst of the accounting scandals. At the same time, the stock market remains an uncertain place to park capital.
"Corporates continue to look attractive," economist Sung Won Sohn of Wells Fargo & Co. said yesterday, noting that the resumption of economic growth last year after the 2001 recession and balance sheet improvements have caused credit risks to diminish. Demand for corporate notes and bonds has been so strong recently that the spread between their yields and those on Treasury securities has narrowed sharply. That means that corporate borrowers, even those issuing "junk" bonds, have been able to bring securities to market at relatively low rates.
They have been well below those of three or six months ago, and in some cases lower than at any time since corporate scandals involving Enron Corp., Tyco International Ltd. and other major companies caused corporate credit spreads to soar.
This "better tone in capital markets is a signal that business confidence and expectations are set to rally," said Robert V. DiClemente of Salomon Smith Barney.
J.P. Morgan's record-low interest rate was part of a planned two-part, $1 billion issue rushed to market Thursday after a good first-quarter earnings report bolstered the company's creditworthiness. The issue drew such strong investor demand that it was increased to $1.25 billion.
The 3.625 percent rate of return on the higher-rated notes was just over three-quarters of a percentage point higher than the yield on five-year Treasury notes, an exceptionally low spread over the yield on the essentially riskless government securities. On the remaining $750 million worth of lower-rated 12-year notes -- which were subordinated debt, meaning it would not be paid off until more senior debt -- the rate was a still low 5.25 percent.
Meanwhile, J.P. Morgan paid off nearly $225 million worth of subordinated notes not due until 2028, but which was costing the bank about 7.5 percent annually.
Other corporations have also been issuing notes and bonds to pay off debt that will mature in the next year or two. Some are doing so to repay money they have borrowed using commercial paper, essentially an unsecured promissory note, while others, such as XTO Energy, will use new money to expand their operations.
Many companies are getting out of the market for commercial paper because it has experienced enormous shocks over the past three years.
In November 2000, a few months before the 2001 recession began, $351 billion of nonfinancial corporate commercial paper was outstanding. By last week, that total had shrunk to only $155 billion, a 56 percent decline in a little over two years.
Part of the decline was due to a drop in demand on the part of companies, which typically use this type of very-short-term financing to cover the cost of holding inventories. During the recession, firms shed inventories like mad.
But the greater factor has been the decline in creditworthiness of some firms and some actual defaults on commercial paper, including those by hard-pressed California utilities Pacific Gas and Electric Co. and Southern California Edison Co. in January 2001. The corporate governance scandals also rocked the commercial paper market, as more investors decided it had become too risky. Between 1991 and 2000, a period in which there were no defaults, that market expanded rapidly.
Now some firms that still have access to this market have decided to insulate themselves from any potential problems there. They are issuing longer-term debt at favorable rates and paying off their commercial paper, analysts said.