Capital Markets

Corporate Bond Rates Surging

''I'm surprised you haven't seen more companies trying to take advantage of'' the shrinking spread, say one credit strategist.
Stephen TaubMarch 8, 2006

The cost of capital is creeping up for many corporations.

Companies are paying their highest average interest rate since November 2002, reported Bloomberg. According to the wire service, which cited data from Merrill Lynch, the average rate on investment-grade bonds stands at around 5.72 percent, up 17 basis points this month.

The wire service also noted that earlier this week, the yield on the much-followed 10-year Treasury note briefly surged to 4.8 percent, the highest since the Federal Reserve began raising rates in June 2004.

Things could be worse, however. The yield premium over comparable Treasuries has fallen to its lowest level in six months, the wire service noted. Corporate issuers are shelling out 88 basis points more than comparable government debt, down from 92 basis points at the end of 2005, and the narrowest spread since August 29.

Not surprisingly, Bloomberg pointed out that underwriting has slowed from January’s $98 billion pace. Altogether, companies have issued $142.5 billion of debt so far this year, compared with $180.2 billion for the entire first quarter of 2005.

“I’m surprised you haven’t seen more companies trying to take advantage of” the shrinking spread, said John Tierney, credit strategist at Deutsche Bank AG in New York, according to Bloomberg.

Indeed, the wire service pointed out, DaimlerChrysler priced $1.25 billion of notes due in 2011 at 115 basis points more than Treasuries, 15 basis points less than for its five-year debt sale last June. The automaker also sold $1.25 billion worth of three-year floating-rate debt that pays 43 basis points more than the three-month London interbank offered rate, 10 basis points less than for a similar note last November.

On the other hand, when Nissan Motor Acceptance, the automaker’s financing unit, sold $1 billion worth of five-year notes earlier this week, it paid 22.5 basis points more than the five-year security it sold a year ago.

Bloomberg also pointed out that the spread between junk and investment-grade corporate bond yields has narrowed by 38 basis points since the end of the year. Citing data from Merrill Lynch, the wire service observed that the spread of 242 basis points is near the narrowest since August.

One possible reason: Moody’s reported this week that the global speculative-grade default rate fell from 1.8 percent in January to 1.6 percent in February, its lowest level since 1997.

In Europe, the speculative-grade default rate actually dropped to zero in February. Among U.S. issuers, the speculative-grade default rate fell to 2.2 percent in February from 2.4 percent the prior month; a year ago, however, it stood at 3.1 percent.

Moody’s suggested, however, that “February’s default rate may represent a cyclical low, and that the pace of defaults will begin to accelerate going forward.”

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