Constellation Brands is a serial acquirer of well-known names in the alcoholic-drink trade. No sooner has it digested one and tidied up its balance sheet than it takes on more debt, ready to buy the next. Ordinarily, this practice would add to its borrowing costs. Not now. On July 28th, it repriced more than $1 billion-worth of loans, on terms normally reserved for investment-grade companies: just 1.5 percentage points over LIBOR (London Interbank Offered Rate: the interest rate at which international banks lend to one another). This followed a previous deep cut in the company’s borrowing costs only last November.
And Constellation is hardly unique. In recent days similar refinancings have been made by Dr Pepper, a maker of fizzy drink; Community Health Systems, a big hospital chain; CSK Auto, a parts manufacturer; Scotts Company, a garden-supplies company; and Dean Foods, a processor of dairy products. All have financial statements below the top rank. All would have found it hard, or at any rate expensive, to borrow in 2002. Now lenders are tossing money at them.
One striking example of how accommodating the market has become is that of UGS, a software firm spun out of EDS, a computer giant, in May to a consortium of private-equity firms. UGS’s credit rating is not even close to investment grade. It has not had a chance to issue a single quarterly report. Yet it recently refinanced a half-billion-dollar loan arranged in May, saving millions in interest.
Wait a moment. Aren’t interest rates in America supposed to be rising? So shouldn’t borrowing be getting dearer not cheaper? Well, official rates are indeed on the increase. So is LIBOR, which has climbed from 1.1% early in the year to 1.6% today. However, the spread between borrowing costs for junk and top-notch credit is narrower than at any time since 1998, during the emerging-market debt crisis, says Chris Donnelly, director of Standard & Poor’s LCD, an information service. This contraction has more than offset the rise in LIBOR — which is in any case still low in historical terms. In 2000 LIBOR twice topped 6.8%. With rates plummeting, 87% of companies refinancing in the past year have done so twice, says Mr Donnelly.
A consequence of the fall in rates has been in the secondary market, for corporate loans sold to institutions, where the number of loans trading at a discount has contracted sharply. More than one-third trade above the price at which the issuers may repurchase them (see chart). This is a record, says the Loan Pricing Corporation, an information firm. It is, observes Meredith Coffey, the firm’s director of analytics, a very good time to be a borrower.
Why are credit markets so strong? One reason is that banks cut lending sharply three years ago, when the economy was less healthy. Having missed the interest income, they are eager to lend again. Second, credit quality is good. Defaults by corporate borrowers have been declining since early 2002. In the second quarter, says Moody’s, a rating agency, upgrades exceeded downgrades for the first time in four years. Third, profits have been strong and cash reserves have risen. Finally, the economy is running well, but not boiling — so the bond market is not overheating. Although there is inflation in some places, others are quieter: retail sales and the car market are slow. For a moment at least, the habitually gloomy credit markets are beaming with optimism.