Savings on Debt Costs Give a Boost to Many Companies
Some people have a hard time figuring how excited they should get about falling interest rates. Jeffrey Sudikoff doesn’t have that problem.
The company he chairs, satellite communications firm IDB Communications in Culver City, has $75 million in bank debt outstanding at an interest rate that floats at two percentage points above the prime lending rate.
Last week, banks dropped the prime half a point, to 8%. A year ago the prime was 10%. For heavily indebted IDB, the difference between paying 12% then and 10% now is $1.5 million in annual interest expense--no small saving for a company that earned $746,000 in the most recent quarter.
“It’s a big help,” Sudikoff said of the rate slide. His shareholders must agree: IDB stock has rocketed from $5.25 earlier in the year to $13 now as interest rates dropped.
It’s companies like IDB that the Federal Reserve has had in mind this year, as the central bank continually pushed interest rates lower to try to jump-start the weak economy.
So far, the recovery is spotty at best; consumers just aren’t in a spending mood, and ever-lower car loan and home loan rates aren’t doing the trick.
Still, the drop in rates will go a long way toward bolstering many companies’ finances, and that will ultimately boost the economy in numerous ways perhaps not yet readily apparent:
* Lower rates will allow some companies to proceed with acquisitions or expansions they might otherwise have put off. Each transaction or expansion pulls the economy up by putting money in someone’s pocket.
* Some firms are refinancing old bond debt at lower cost; others, such as IDB, will get an automatic benefit as their bank loan rates decline with the prime. Either way, the interest savings will translate into higher earnings for perhaps thousands of companies.
For Wall Street, each drop in rates nails another plank into the “floor” under stock prices: Though many investors are reluctant to buy stocks at their current near-record-high prices, they also become more reluctant to sell because lower rates promise better earnings sooner rather than later--while everyone waits for the economy to rebound and bring the real profit surge.
Of course, the benefits of lower interest rates aren’t spread evenly across Corporate America. The weak will benefit more, while some of the stronger companies may actually lose because their cash hoards will earn less from investments.
Lowell Sears, chief financial officer for bio-tech giant Amgen Inc. in Thousand Oaks, can empathize with savers who lament having to roll over maturing bank CDs at puny yields. Amgen has a cash balance of $300 million that it must invest, and Sears has been forced to put more of those dollars into longer-term maturities--including some three-year Treasury notes--to keep the earnings up.
The average term of Amgen’s investments now is about one year, up from a nine-month average term earlier in the year, as Sears has sought out higher yields. Yet even if net interest earnings continue to drop for Amgen, the bottom line won’t be hurt much: The company’s hot-selling drugs produced 95% of Amgen’s net income in the recent quarter; interest earnings contributed just 5%.
Overall, financial executives at a broad cross-section of Southland companies say the end result of lower interest rates has to be good news for their shareholders and the economy:
* At oil giant Atlantic Richfield, Chief Financial Officer James Morrison recently refinanced $500 million in bonds. Arco had been paying about 10% on the debt. Morrison was able to refinance those bonds at 9%--and best of all, he said, the investors were willing to give the company that rate for 40 years. Generally, investors are only willing to buy such bonds for terms of 25 to 30 years.
The refinancing of older, higher-yielding debt is responsible for much of the surge in total corporate bond issuance this year, already a stunning $332 billion. The average yield on new AA-rated long-term industrial bonds now is about 9.4%, nearing the 1980s low of 9.16% in 1986. If rates drop below 9%, firms that sold bonds as recently as 1988 could rush to refinance, experts say.
* Many companies are refinancing short-term debt as well, negotiating for better deals from their banks as the Fed lowers the banks’ cost of money. Sunrise Medical, a Torrance-based producer of wheelchairs and other medical equipment, this week rolled $4 million of bank debt, at 8%, into a 180-day loan at 6.75%, said Ted Tarbet, chief financial officer.
* Even companies that are debt free see benefits in lower rates. Robert Schulze, finance chief at Bridgford Foods in Anaheim, said his company has been able to finance its expansion internally for many years. An addition to the firm’s refrigerated warehouse in Anaheim will soon be going up, he said, paid for out of profits.
But, Schulze said, “we’re also looking at opportunities that might require us to borrow,” and that becomes more enticing as interest rates slide.
Likewise, El Segundo-based Computer Sciences Corp., a computer services company that is branching out from government contracts to commercial contracts, is always in the market for potential acquisitions of smaller companies that would complement its business, said Leon Level, chief financial officer. With lower interest rates, Level said, “a lot of transactions that didn’t look so attractive a year ago are starting to look more interesting.”
None of these companies can single-handedly turn the economy around, of course. And for many, lower interest costs may not pay off as well as might be expected. The finance chief of one large Southern California manufacturer noted that, even as banks cut loan rates, “they’re coming back to us and asking for substantially higher fees for credit lines and other services.” The banks are fighting for their own bottom lines.
Still, the optimism that lower rates are engendering in Corporate America may go a long way toward putting the economy back on a solid growth track--which is what everyone wants.
Corporate Borrowing Costs Slide A major benefit of falling interest rates is that companies pay less in interest costs--leaving more profit for the bottom line. That may prove extremely important in bolstering record-high stock prices over the next year. Average yield on new corporate bonds: (Yield on new AA-rated industrial bonds, 25- to 30-year terms) ‘80: 12.18% ‘81: 14.80% ‘82: 14.51% ‘83: 12.04% ‘84: 13.23% ‘85: 11.76% ‘86: 9.16% ‘87: 9.53% ‘88: 9.91% ‘89: 9.69% ‘90: 9.90% ‘91: 9.40% Source: Salomon Bros.
The Rush to Refinance Companies have issued $332 billion in new debt so far this year as interest rates have fallen, already surpassing the full year total of $296 billion for 1990. Much of the new debt is refinancing older debt that carried higher interest rates. Corporate debt issuance (convertible and non-convertible bonds) (Billions)Source: IDD Information Services
