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Credit FAQ:
Why Do Companies Issue Debt When They Don’t Seem To Need The
Money?
Publication date: 20-Oct-2010
Primary Credit Analyst: John J Bilardello, New York (1) 212-438-7664;
john_bilardello@standardandpoors.com
Secondary Contact: Diane Vazza, New York (1) 212-438-2760;
diane_vazza@standardandpoors.com

Many U.S. corporations have taken advantage of near record-low interest rates to issue new debt. From January through
August 2010, issuance averaged $75 billion, and then jumped to $138 billion in September. Yet at the same time, economies
in most of the developed world remain sluggish, with stubbornly high unemployment. Furthermore, this debt issuance has been
happening while many corporations have amassed large amounts of cash, and across multiple categories. Issuance of
speculative- and investment-grade debt, convertible debt, and bank loans has all risen in recent months--even as companies
generally have maintained large amounts of cash on their books.

Why would companies want to issue so much debt? Standard & Poor's Ratings Services answers that and other frequently
asked questions here.

Frequently Asked Questions

What are some of the reasons behind the surge in debt issuance?

One of the most significant reasons, in our opinion, is that many corporations facing debt maturities in coming years are
opportunistically seizing low-cost funding alternatives now, while interest rates are historically low. During the next four years,
approximately $1.5 trillion in corporate debt will mature. Some issuers are simply refinancing their existing debt. But others are
tapping the credit markets now so they can "prefund" subsequently maturing debt while interest rates remain low.

They're making the judgment, in our opinion, that it's better to incur additional debt now for their soon-to-be-maturing
corporate credit obligations than to confront uncertain capital markets some months down the road, when interest rates
might be higher. Those that choose this "prefunding" route will potentially carry additional debt on their books until their old
debt matures. Depending on the borrower's specific financial profile, this additional debt could become a negative rating factor.
But we believe that low interest rates will mitigate this possibility as long as they prevail.

For investment-grade companies, rates have been at or near record lows. In August, drug and health products company
Johnson & Johnson, for instance, sold $550 million of 10-year notes at 2.95%. In September Microsoft Corp. sold $991
million of 3% 10-year notes. We maintain 'AAA' ratings on both of these companies. But even lower-rated investment-grade
companies are taking advantage of the prevailing low rates. Cliffs Natural Resources Inc., a mining and natural resources
concern rated 'BBB-', could sell $499 million of 10-year notes at 4.8%.

In addition to the surge in debt issuance, we've seen a rise in the issuance of leveraged loans. Much of this, we believe, is
attributable to corporate issuers capitalizing on a robust leverage-finance market to refinance upcoming debt obligations
opportunistically. Standard & Poor's Leveraged Commentary and Data group reported that leveraged loan volume increased
by $30 billion in September, compared with a rise of only about $9 billion in August.

What are some other reasons that companies are borrowing now?

Investment-grade companies that are borrowing now have the opportunity to issue debt not only with lower interest
payments, but also with extended maturities, locking in low rates for longer periods. In the first three quarters of 2010, 25%
of the debt nonfinancial investment-grade companies issued had a maturity of 15 years or longer. In 2009 that figure was only
14%. We expect companies to keep taking advantage of this opportunity if the yield curve continues to flatten.
 Why would companies with enough cash tap the debt markets?

Although many companies, especially larger investment-grade issuers, have record (or near-record) amounts of cash on their
books, not all of it is easy to use because it could be domiciled overseas. It's expensive for U.S. multinational companies to
repatriate cash from foreign operations because U.S. law requires that they pay the corporate income tax (up to 35%) on
repatriated profits, but leaves those profits untaxed if they remain offshore. Thus it may actually be cheaper for these
companies to tap the domestic credit markets than to draw on their offshore profits.

Are speculative-grade companies successfully using the capital markets for debt financing?

As was the case throughout the recession, speculative-grade companies continue to have less access to the credit markets
than their investment-grade counterparts. But now, the credit markets seem more open to speculative-grade issues. In
September, nonfinancial speculative-grade companies issued $22 billion in debt, totaling approximately $120 billion since the
beginning of the year. This means they're already closing in on the recent record year of 2007, which had $121.8 billion in
debt.

One reason that these companies have gained traction among many investors, we believe, is that institutional investors such
as pension funds, high-yield bond funds, and exchange-traded funds, among others, are increasingly searching for higher yields.
With many other debt instruments or investments generating relatively low yields, institutional investors are more eager to buy
these bonds--and companies have responded accordingly.

How has overall credit quality affected investor appetite for new debt?

Distressed debt has been declining in recent months. We view this as an added incentive for investors to consider new issues.
When defaults were high, speculative-grade issuance was more difficult than it is now. And issuance for both speculative- and
investment-grade securities was muted in the spring of 2010, when the Greek debt crisis swept the markets. However, the
12-month trailing U.S. speculative-grade corporate default rate has been falling steadily from double-digit recessionary levels,
and we expect it to have reached about 4% in September. Our baseline projection for speculative-grade defaults in June 2011
is 2.8%, which lies between our most optimistic and our most pessimistic projections of 2.5% and 4.5%, respectively.

Although the economy is improving only slowly, we've recently taken more upgrades than downgrades across a broad
spectrum of companies. In third-quarter 2010, we recorded 74 upgrades and only 49 downgrades--approximately the same
ratio of upgrades to downgrades that we saw in the second quarter. In turn, we believe that as credit quality continues
improving in general, companies will find it easier to issue new debt and investors will find that debt more attractive--though of
course this will vary by company.

What signs might we look for to see if the recent surge in debt issuance points to a stronger
economy?

We think one of the signs of an improving economy will be a greater preference for companies to swap adjustable-rate debt
for fixed-rate debt. An issuer who believes that the economy will strengthen measurably during the next few years will likely
also believe that interest rates will rise with increased economic activity. Adjustable-rate securities would then become an
increasing liability, whereas the fixed-rate payments might remain low. So far this year, however, we haven't seen any
significant replacement of adjustable-rate debt with fixed-rate debt, although we've heard that some issuers may be
considering it. In our view, however, it may currently be more a matter of chatter than fact.

Writer: Robert McNatt

Related Criteria And Research

What's Up With All That Cash At U.S. Companies?, Oct. 13, 2010
U.S. Corporate Credit Fires on All Cylinders, Oct. 7, 2010

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