Flood of Corporate Borrowing Causing Commotion in Markets

A deluge of corporate borrowing--spurred in large part by worries about the year 2000 computer bug--is causing havoc in financial markets and sending some measures of “credit risk” to their highest levels since 1987.

That could put further upward pressure on key interest rates, including those for mortgages, analysts warned.

Although Treasury bond yields fell on Thursday, yields on corporate and mortgage-backed bonds rose. Indeed, Treasuries benefited as some investors sought safe haven from turmoil elsewhere in the market, pushing the yield on the bellwether 30-year T-bond to 6.04% from 6.10% on Wednesday.

Traders were focused Thursday on action in the so-called derivatives market, where companies and institutional investors use hybrid securities to make or hedge bets on interest rate trends.

Prices for a key type of derivative--interest rate swaps--rose sharply, which traders said reflected a rush of companies attempting to protect themselves against rising market rates.

In a swap, a corporate treasurer planning to borrow via a bond offering might enter into an agreement with another institution to hedge against higher rates.

The institutions on the other side of those agreements were demanding greater premiums Thursday--in fact, the highest premiums on such swaps since the October 1987 stock market crash.

Swap “spreads” reflect the interest rate premium that a double-A rated corporate borrower has to pay over Treasury securities. Spreads on 10-year swaps ballooned Thursday to more than 1.15 percentage points above yields on 10-year Treasury notes.

There were some rumors Thursday that a major bank, bond dealer or hedge fund had taken large losses on derivatives, which also could have hurt the market.

But derivatives traders at five out of six firms said they believed the rumors to be exaggerated if not completely untrue.

Most traders said the upheaval in the swaps market is being pushed almost exclusively by the huge supply of corporate bonds on the horizon.

Through July, according to Securities Data Co., $587 billion worth of investment-grade corporate bonds had been issued this year--more than two-thirds the amount issued in all of 1998. Now, tens of billions of bonds are scheduled for sale in coming weeks.

A key reason for the bond glut is concern over the Y2K bug and the potential for financial and communications snarls Jan. 1 if computers will read the year as 1900 instead of as 2000.

“Y2K is clearly moving ahead in people’s consciousness,” said economist Ian Shepherdson of High Frequency Economics.

Corporations and government agencies have spent billions of dollars fixing the problem, and the cautiously optimistic consensus seems to be that there will be no New Year’s Day disaster.

However, the outside chance of havoc in the payments system, for example, is causing insurance firms, pension funds and other big buyers of bonds to signal that they may shy away from securities purchases later in the year.

“Nobody’s announcing that Y2K is the reason, but they are thinking about it,” said Kevin Akioka, senior portfolio strategist at Payden & Rygel in Los Angeles.

The buyers’ skittishness, in turn, is causing corporations to rush to borrow now rather than try to sell bonds in the fourth quarter.

“No one wants to be questioned in the fourth quarter as to why they did not [complete financing] beforehand,” said Ethan Heisler, vice president of corporate bond research at Salomon Smith Barney.

Although rising bond yields could deter some corporate borrowers, it isn’t clear how many are prepared to step away.

*

Bloomberg News and Reuters were used in compiling this report.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Borrowing Binge

Major U.S. companies are already on pace to borrow more than $1 trillion this year throughbonds, and a rush of borrowing is expected in coming weeks. Issuance of investment-grade corporate bonds, in billions:

Annualized pace: $1,006 billion

Through July: $587 billion

Source: Securities Data