With U.S. interest rates falling and expected to drop further, corporate treasurers are rushing to issue new bonds in an effort to retire their prior, costlier debt.
Financial analysts say the growth of new bond issues has gathered pace since the yield on the benchmark 30-year Treasury bond settled below 8%, compared to a high of 9.29% in March.
"I don't think we're seeing a boom in capital spending, but rather a boom in companies refinancing older debt," said David Blitzer, senior economist at Standard & Poor's Corp.
Although corporations have to pay investors higher yields on their bonds than the government does, the rates on corporate and Treasury bonds tend to rise and decline in tandem.
To the degree that corporate bond rates fall, companies are able to save money on their debt by issuing new securities at lower yields. The yield is the interest a company pays on its bonds.
"It's a pattern that will continue, at least for the next few months," Blitzer said, referring to the stepped-up pace of corporate bond issues.
Companies are eager to lock in the lower yields because the softness in the economy has begun to erode their profits. Indeed, the weakness in the economy is the main reason that the Federal Reserve has been nudging interest rates lower.
United Technologies Corp., which recently offered $300 million worth of 30-year bonds yielding 8.974%, said the lower interest rates allowed it to successfully refinance its short-term debt.
"We decided to bring our recent issue because of the attractive rate environment," said Fred Flynn, vice president and treasurer of United Technologies.
Because the yield on the new United Technologies bonds is slightly more than a percentage point above the 30-year Treasury bond's yield, currently trading at 7.88%, other companies have been able to narrow the spread by offering "puts."
Puts give the holders the option of selling the bonds back to the issuer before the maturity date. Many investors want such a clause to protect themselves against events, such as rising interest rates or leveraged corporate buyouts, that lower the value of the bond.
New England Telephone & Telegraph Co., for instance, recently sold $350 million worth of 40-year bonds, yielding 7.95%, with a seven-year put. The yield is just a scant 12 points--or hundredths of a percentage point--above the rate on seven-year Treasury notes.
"The put has the effect of removing interest rate risk. Investors are sacrificing in terms of yield what they demand in terms of insurance against an unforeseen rise in interest rates," said John Lonski, a senior economist at Moody's.
Similarly, companies that sell bonds with puts are betting that interest rates will not rise, underwriters say.
"Someone (issuing bonds with a put) would have to have a strong feeling that interest rates are going to fall for a long period and stay low," said Jack Stroud, senior vice president and syndicate manager at Nikko Securities Co. International Inc.
"I don't see that happening myself," Stroud said, but other experts disagree, saying the weakness in the economy means the Fed will have to push rates even lower to avert a recession.
Standard & Poor's Blitzer said he expects U.S. interest rates to decline gradually over the next six months, driving the yield on the 30-year Treasury bond down to around 7.40% by May.
"Rates have come down. All signs show that they will continue to come down," Blitzer said.