Bad Credit? For Corporate Borrowers, It's Not A Problem

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NEW YORK — With rising fears of a prolonged recession and stomach-churning moves in the stock market, corporate bond markets have performed so well this year they look like they're part of a parallel universe.

Banks are reluctant to lend, but large corporations with the weakest credit ratings have had little trouble finding investors happy to hand over their cash.

Companies sold $24.6 billion in junk bonds in August, the eighth-best month ever for sales, according to Thomson Reuters data. Among those feeding in the market: Goodyear Tire & Rubber Co., Rite Aid Corp. and acquisitive power giant NRG Energy Inc.

So how is it that companies with bad credit find it so easy to borrow in this economy?

"A lot of that has to do with living in a world where investments pay less than 1 percent," said Diane Vazza, head of fixed income research at rating agency Standard & Poor's.

The Federal Reserve's near-zero interest rate target means sticking cash in savings accounts or money market funds will yield next to nothing. Stocks are increasingly volatile. The Standard & Poor's 500 index fell 4.7 percent in August, though it's up 3.8 percent so far this month.

Given the alternatives, many investors have piled into corporate bonds, which offer yields ranging from 3 percent to 8 percent and, more importantly, the promise of getting your money back.

Investors have been yanking money out of stock funds and putting them in bond funds for much of the year. But the trend is intensifying. In the week ended August 25, investors took $4.6 billion out of stock funds and dropped $5.96 billion into bond funds.

"I think people are saying, 'The economy is sluggish; How are stocks going to go up?'" said Martin Fridson, global credit strategist at BNP Paribas. "And you have to wonder how are (companies) going to increase earnings? They've done all the cutting they can."

Bond investors, by contrast, don't have to worry about earnings. They just need corporate borrowers to pull in enough cash to cover their interest payments.

For bond fund managers, the quickest and cheapest way to put the flood of cash to work is to buy newly issued debt. Borrowers with junk ratings -- those with the greatest chance of going under -- have been able to tap them for $176.6 billion this year, a record-setting pace. Of that amount, 61 percent was used to reduce other debts or push due dates into the future. Toys R Us, for instance, last month sold $350 million in notes paying 7.37 percent and plans to pay off more expensive debt.

The ability to refinance and roll over their debts has rewarded many companies with a second lease on life, Vazza said. It's the key reason fewer corporate borrowers have missed their payments to creditors. S&P's default rate has dropped from 11 percent of all low-rated bonds at the start of the year to 5.5 percent.

The refinancing spree has also shrunk the threat posed by a wave of debt coming due over the next five years. This spring, market pundits and bloggers warned that this $800 million pile of bills, called a "maturity wall," would crush borrowers and shove many companies into bankruptcy.

This maturity wall now looks less daunting thanks, in part, to the savings investors have handed over to bond funds. Without it, many more companies would have fallen into bankruptcy.

It's a little noticed benefit of retail investors' newfound preference for fixed-income investments over domestic stock funds. Some see this change of heart as a symptom of a "bond bubble" and argue that Americans have turned too pessimistic on stocks that look cheap by many measures.

Fund flows usually follow performance, and so part of fixed-income's popularity with investors is probably a result of return-chasing. Americans love a winner, and high-yield bonds have returned 8.9 percent this year, after posting a 57.5 percent return in 2009.

David Rosenberg, chief economist and investment strategist at Gluskin Sheff, argues that many Americans are making a sensible investment shift. Members of the baby boomer generation need to limit risks and shy away from stocks as they near retirement.

Junk bonds are the riskiest of fixed-income investments because they're most likely to default. But that danger has plummeted over the past year.

"It's called 'junk,' but it's the part of the bond market that offers some of the best risk-reward attributes," Rosenberg said. The typical high-yield junk bond, for instance, pays 5.6 percentage points more in yield than the 2.7 percent you get from a 10-year Treasury note. "Are they risky? Yes, they are. But the risks are actually lower because corporate balance sheets are arguably stronger today than at any point in the past 15 years."

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