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Debt Markets Bifurcate as Banks Hoard, Bond Funds Flourish: Credit Markets

Debt Markets Bifurcate as Banks Hoard, Bond Funds Flourish: Credit Markets

Source:  Bloomberg News By Christine Richard and John Detrixhe – Sep 30, 2010

Record-low borrowing costs for the biggest U.S. companies such as Microsoft Corp. are failing to trickle down to Mel Hodges’s five-person computer consulting firm in Pennsylvania.

Microsoft, the world’s largest software maker, led at least $340 billion of U.S. corporate bond offerings this quarter, the busiest July-through-September period on record, according to data compiled by Bloomberg. Smaller businesses struggled as banks pared commercial and industrial lending 11.3 percent in the past year, Federal Reserve data show.

While yields on corporate bonds have fallen, rates on commercial and industrial loans of less than $100,000 climbed. The divergence shows that almost two years after lowering its benchmark interest rate to a range of zero to 0.25 percent, the Fed’s efforts to stimulate the economy have done little to help smaller businesses that create most U.S. jobs.

“Larger companies can go to the market and that market is largely repaired,” said Adolfo Laurenti, deputy chief economist at Mesirow Financial Inc., a broker-dealer and money manager in Chicago. “If you’re a smaller company and you don’t have access to the market, you need to go through some intermediary such as banks. You are getting the losing end of the stick because banks have become very risk averse.”

Redmond, Washington-based Microsoft, one of four nonfinancial U.S. companies with top AAA credit ratings, sold $4.75 billion of bonds on Sept. 22, including 3-year, 0.875 percent notes and 5-year, 1.625 percent debt. The coupons were the lowest on record for those maturities, according to the Barclays Capital U.S. Corporate Index of investment-grade debt.

Credit Line

Hodges, 55, said he was considering asking to expand a $25,000 line of credit to $40,000 earlier this year when the bank raised the possibility of cutting the line to $12,000. Ultimately, the bank, which Hodges declined to name, maintained the existing line.

Elsewhere in credit markets, the cost of protecting American International Group Inc.’s debt from default fell to the lowest since July 2008 after the insurer agreed with U.S. regulators to repay its bailout by converting the government’s holdings into common shares.

Credit-default swaps on AIG dropped 21.3 basis points to a mid-price of 235 at 11:25 a.m. in New York, according to broker Phoenix Partners Group. The contracts have lost 369.3 basis points since May 25 and are down 3,448 basis points from their record in May 2009.

Outperforming Government Debt

Corporate bonds worldwide are poised to outperform government notes in the three months since June, a reversal from the second quarter. The debt has returned 3.897 percent this quarter, compared with 2.295 percent for government debentures, according to Bank of America Merrill Lynch global index data. Company bonds have gained 9.08 percent in 2010.

Leveraged loan returns are rebounding from an April- through-June loss. The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 index has returned 4.01 percent this quarter, following a loss of 2.586 percent in the preceding period. For the year, loans have gained 5.61 percent.

Corporate bond sales total at least $803.2 billion worldwide this quarter. While that’s up from $595.8 billion in the second quarter, offerings declined from $940.4 billion in the first three months of 2010, Bloomberg data show. Issuance in the U.S. this month of $145.4 billion is the highest for any September.

Record-Low Yields

Sales are soaring as borrowers take advantage of investment-grade corporate bond yields as low as 3.645 percent on Sept. 28, the lowest ever, down from 4.935 percent a year earlier, according to Bank of America Merrill Lynch index data.

The spread over the federal funds rate on commercial and industrial loans of less than $100,000 by U.S. banks rose to 4.67 percent in May, compared with 4.37 percent a year earlier, Fed data show.

Banks pared commercial and industrial lending to $1.24 trillion in the week ended Sept. 8 from $1.4 trillion a year earlier, Fed data show. Banks’ holdings of government debt reached a record $1.6 trillion in the week ended Sept. 1, 15 percent more than a year earlier, according to Fed data compiled by Bloomberg going back to 1973.

Owners of small businesses who seek to finance their ventures by tapping equity in their houses are being squeezed, with the median price of an existing home in the U.S. falling to $178,600 in August from $203,200 two years earlier, according to the National Association of Realtors in Chicago. One in six small business owners have a mortgage on their home that is used to fund their firms, according to data from the National Federation of Independent Business.

‘Desperately Need Funds’

“A lot of people that desperately need funds are either in industries or locations that are undergoing much distress and those businesses may not have been financed right to weather today’s economic climate,” said Bob Seiwert, a senior vice president at the American Bankers Association who heads its Center for Commercial Lending and Business Banking.

Banks also often look to the value of a borrower’s personal assets when making small business loans, Seiwert said. The decline in residential property values over the past three years means people looking to start or expand a business often don’t have any equity left in their homes to tap, he added.

Hodges said it’s “really offensive” he can’t get money from banks to expand his business in Easton, Pennsylvania.

Investor Appetite

“It’s a great life being in business, but many nights it keeps you up trying to figure out how you’re going to make payroll,” he said.

That may not be an issue for even the least-creditworthy companies with access to debt markets, which have benefited from investor appetite for corporate bonds. Investors poured $480.2 billion into mutual funds that focus on debt in the two years ended June 30, more than went into stock funds during the Internet bubble, according to the Washington-based Investment Company Institute.

High-yield, or junk, debt sales of $191.4 billion this year have surpassed the annual record with three months to go in 2010, Bloomberg data show. Speculative-grade debt is rated below Baa3 by Moody’s Investors Service and lower than BBB- by S&P.

Freescale Semiconductor Inc., the Austin, Texas-based computer chipmaker bought in a 2006 leveraged buyout led by Blackstone Group LP, sold $750 million of 10-year, 10.75 percent notes on Sept. 22 after increasing the size of its offering from $500 million. Moody’s ranked the debt Caa2, eight levels below investment grade, and S&P graded it an equivalent CCC. Debt carrying that rating is deemed “currently vulnerable” to non- payment, according to S&P.

Buybacks, Acquisitions

Proceeds from Microsoft’s sale may be used to fund working capital, capital expenditures, stock buybacks and acquisitions, it said in a regulatory filing. The company also plans to pay for dividends and share repurchases because much of its cash is held overseas.

Microsoft spokesman Peter Wootton declined to comment.

U.S. President Barack Obama signed the Small Business Jobs Act on Sept. 27 and said the legislation, which will cut taxes and provide credit help to small businesses, is an “essential” step to aid job growth.

The Small Business Administration says small companies created 64 percent of net new jobs in the past 15 years. The U.S. economy continues to stagnate with unemployment at 9.6 percent last month, according to the Labor Department.

“Although most firms faced problems obtaining credit during the depths of the crisis, over the past year or so a divide has opened between large firms that are able to tap public securities markets and small firms that largely depend on banks,” Fed Chairman Ben S. Bernanke told a gathering of central bankers last month in Jackson Hole, Wyoming.

The slowdown in borrowing isn’t all due to tighter lending standards, according to Seiwert of the bankers group.

“The reason that you don’t see lots of loan volume in the small business area is a lack of demand,” he said. “Economists have indicated that the recession is over but most small business owners haven’t seen that recovery in terms of customers walking through the door.”

To contact the reporters on this story: Christine Richard in New York at; John Detrixhe in New York at

To contact the editor responsible for this story: Alan Goldstein at