The Federal Reserve’s two corporate bond-buying initiatives—one of which became active this week—turbocharged the issuance of new corporate bonds before it started. And some of the largest online retailers joined in to seize the opportunity to borrow at favorable rates.
Analytics firm Intelligize Inc. looked at the 100 online largest retailers based in North America listed in the 2020 Digital Commerce 360 Top 1000 and found 13 of them issued $38.823 billion worth of bonds from March 1 through May 8. During the same period in 2019, the same universe of retailers made three bond offerings, totaling $8 billion. Half of the 2019 total for the period consisted of $4 billion in bonds issued by Walmart Inc. (No. 3 in the Top 1000). The results for each year included only bond issues registered with the U.S. Securities and Exchange Commission for sale to the public.
Corporations issue bonds to raise financing for a variety of reasons such as to fund ongoing operations, mergers and acquisitions, or expanding the business. The term is usually applied to longer-term debt instruments, with maturity of at least one year. Corporate debt instruments with maturity shorter than one year are referred to as commercial paper.
The opportunity to issue bonds emerged after the Fed’s March 23 announcement that it would start purchasing corporate bonds. The Fed then followed up April 9, saying the buying would include riskier high-yield (also called “junk”) bonds. The two-part bond-buying program—which will purchase on the secondary market and also directly from corporate issuers—was created as part of the Coronavirus Aid, Relief and Economic Security Act (CARES Act).
The anticipation of the Fed action provided stability to the corporate bond market by creating an implied “backstop” for investors, says Rob Peters, senior director of customer experience and knowledge at Intelligize. By themselves, the Fed announcement opened the floodgates, stimulating enormous growth in corporate bond offerings in late March and all of April, even before the central bank started buying bonds, he says.
“Corporations that needed to add to their liquidity to endure the COVID-19 economic shutdown but facing a skeptical market were able to join those corporations with more robust balance sheets taking advantage of the lower-interest-rate environment in issuing debt,” Peters says. The extra cash could be necessary, he says, when retailers face uncertainty about when stores will reopen and how bad the economic downturn might become.
High-yield bonds are bonds rating agencies deem to be riskier than higher-rated “investment grade” bonds. High-yield bonds have a higher risk of default or other problems that might affect the issuer’s credit rating. But, to make them attractive to investors, they also offer higher yields.
Apple gets cheap cash while Kohl’s does not
Most of the retailers that issued bonds did so to shore up their available cash. But an apparent exception is Apple Inc. (No. 2 in the Top 1000). The technology giant already had about $200 billion in cash on hand, according to its quarterly earnings statement issued May 1. In that case, Peters says, Apple’s $8.5 billion bond offering was likely made to borrow cash at extremely favorable rates. Apple issued its bonds in four parts—referred to as tranches—with due dates from 2023 through 2050. The interest rate on the shortest-term bonds was 0.75%. The bonds due in 2050 had an interest rate of 2.65%. No retailer among the 13 bond-issuing retailers Intelligize examined offered a bond offering with a lower interest rate.
Apple’s ability to borrow at such low rates indicates investors have high confidence in the company’s ability to pay the money back. In its prospectus, Apple said it would use the proceeds of the bond sale “for general corporate purposes,” including stock repurchases, payment of dividends, funding for working capital, capital expenditures, acquisitions and repayment of other debt.
Besides Apple, the only retailer in the group paying less than 2% was Costco Wholesale Corp. (No. 16). The warehouse club divided its $4 billion bond offering into three tranches, with rates from 1.375% to 1.75%.
While they were not able to borrow as cheaply as Apple or Costco, Most of the 13 retailers Intelligize examined paid rates less than 5% on most tranches of their bond offerings. A notable exception was department store chain Kohl’s Corp. (No 21) issued $600 million in bonds due at 2025—at an interest rate of 9.5%. That’s the highest rate paid by the group of 13 retailers.
Kohl’s says the proceeds of its bond sale will go to things like funding its share repurchase program, meeting its working capital requirements, the repayment or refinancing of debt and financing capital expenditures. The Kohl’s prospectus also says: “The impact of and actions taken in response to COVID-19 have had a significant impact on the retail industry generally and our business, starting in the first quarter of the fiscal year 2020. We cannot presently estimate the full impact of COVID-19, but we expect it to continue to have a material adverse impact on our business, financial condition, and results of operations.”
In addition to issuing bonds to the public, retailers have been drawing down credit lines and issuing less-regulated private placements of debt instruments. Gap Inc. (N0. 23), for example, recently raised $2.250 in a private placement of senior secured notes and also entered into a $1.868 billion asset-based revolving credit agreement. Gap will use a part of those proceeds to redeem the previously issued $1.25 billion unsecured notes due April 2021, Gap says. The retailer did not disclose further terms. The notes were offered only qualified institutional buyers, such as pension funds, endowments and foundations. An unsecured note is a loan that is not secured by the issuer’s assets.
The overall corporate bond market
According to the Securities Industry and Financial Markets Association (SIFMA), corporations issued $834.3 billion in investment-grade and high-yield bonds for the year-to-date through April. That’s a 68.8% increase from $494.2 billion issued for the same period in 2019. The yearly increase in March and April was 119%, reaching $34.3 billion, compared with $243.7 billion in March and April 2019.
As the global COVID-19 pandemic spreads, the U.S. economy shrank at an annualized 4.8% pace in the first three months of the year. And that contraction may intensify in the second quarter. The Fed’s plans to buy company debt have pushed down yields on investment-grade corporate bonds to an average of 2.67%, close to all-time lows. Even some junk-rated companies are getting cheaper financing.
“Fed support may ease a short-term liquidity crunch, but it doesn’t cure credit risk,” Bill O’Neill, senior portfolio manager at Income Research + Management, recently told Bloomberg News. His firm is considering how to deal with bonds sold by energy, finance and property companies that he worries might not survive the onslaught.
Some investors aren’t worried about increasing debt levels, which may be temporary. Companies are building up more liquidity, which gives them more options in the future, said John McClain, a money manager at Diamond Hill Capital Management.
“One of the reasons we’re attracted to investment grade is because some of these businesses do have a number of ways to win and ways to survive,” McClain said. “You can cut [capital expenditures], dividends, buybacks and acquisitions. These are very simple levers than can plug up a lot of the cash flow need.”
McClain favors companies that were in a strong position before the pandemic and sees longer-term opportunities in the energy sector companies that survive the crisis, as demand rebounds in 18 to 24 months.
Fed action as of now
On Tuesday, one of the Fed’s two bond-buying initiatives, called Secondary Market Corporate Credit Facility (SMCCF), started making purchases of eligible exchange-traded funds (ETFs) invested in corporate debt. The “preponderance of ETF holdings” will consist of those mainly exposed to U.S. investment-grade corporate bonds, with the remainder primarily exposed to U.S. high-yield corporate bonds, according to the Fed statements.
ETFs are investment funds traded on stock exchanges, much like stocks. ETFs hold assets such as stocks, commodities, or bonds. During the first two days of buying under the SMCCF initiative, the Fed purchased $305 million of ETFs, according to data published Thursday.
The second Fed initiative—designed to buy debt directly from bond issuers and dubbed the Primary Market Corporate Credit Facility (PMCCF)—will launch shortly, according to the announcement.
The U.S. Treasury will assist the SMCCF and PMCCF with $75 billion in funding. For every dollar the Treasury invests, the Fed will purchase up to $10 in bonds via the two bond-buying initiatives, meaning the combined size of SMCCF and PMCCF could reach $750 billion.
Bloomberg News contributed to this report.
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