Wall Street Journal - March 22, 2000
Big Borrowers Are Unfazed By Federal Reserve's Moves
By PAUL M. SHERER and GREGORY ZUCKERMAN Staff Reporters of THE WALL STREET JOURNAL
It isn't only the stock market that is defying the Federal Reserve. So are (get ready for a big list) the bond market, the mortgage market, the corporate-loan market. In short, a lot of what has to do with borrowing.
"The miracle is that mortgage rates have fallen in the face of Fed" rate increases recently, says Louis S. Barnes, a partner at Boulderwest Financial Services. "I've never seen anything like it." Indeed, while 30-year mortgage rates are up from a year ago, the current average of 8.24% is down from 8.38% on Feb. 18, according Freddie Mac, despite the Fed's efforts.
Even though the Fed raised its key interest-rate target once again Tuesday, hoping to lift all kinds of borrowing costs and slow the red-hot economy, it is suddenly finding it more difficult to get rates higher and keep a lid on borrowers. This suggests that more rate increases may be needed in the months ahead, which may eventually, of course, raise mortgage rates, corporate interest rates and the whole lot. It just hasn't been happening lately.
For a while, the Fed was having success in its campaign to raise borrowing costs in an effort to slow the economy and forestall inflation. In February, Fed Chairman Alan Greenspan cited a jump in yields on triple-B-rated corporate bonds as evidence that the rate increases by the Fed are "already moving in the direction of containing the excess of demand" in the economy. Partly as a result of the higher rates, issuance of bonds and loans had slipped for several months.
But interest rates on Treasury securities are dropping now, sending the rate on 10-year Treasurys to 6.133% Tuesday from 6.79% since Jan. 20.
Even corporate rates are starting to ignore the Fed. Triple-B-rated companies, or those judged by Moody's Investors Service to be at the lowest end of the investment-grade category, now face an interest rate of 8.28% to sell 30-year bonds, down from 8.5% just over a week ago and a peak of 8.55% in October. (Moody's calls these Baa, while Standard & Poor's calls them triple-B).
That's not to say the Fed isn't having any impact. Triple-B-rated companies paid rates of just 7.5% a year ago. But many companies aren't letting the higher rates slow their borrowing just yet, just as stock investors have been unbowed by the Fed's threats. After a slow January and February, new corporate-bond issues and new syndicated loans to riskier borrowers (known as leveraged loans) have increased lately. This year to date, a heavy $187 billion of U.S. corporate bonds has been issued, down only slightly from $203 billion in the year-earlier period, research firm CommScan LLC says. In leveraged loans, volume has hit $11.8 billion so far in March, up from $8.2 billion in the year-earlier period, according to research firm Portfolio Management Data LLC. Interest rates for leveraged loans have actually come down in recent months.
"I wouldn't say the Fed isn't accomplishing anything, but issuance is at the same pace as last year as more issuers shift to shorter debt," said Dennis Adler, corporate-bond strategist at Salomon Smith Barney.
For all the attention paid to the Fed, it has the power to move only two arcane, short-term rates, which have a big impact only if other rates move up with them. In many ways, the Fed has only blunt tools for raising borrowing costs for companies and individuals. Tuesday, the Fed raised the key rate it controls, the so-called federal-funds rate, to 6% from 5.75%. The fed-funds rate is the rate banks charge each other for short-term loans. Banks usually then raise the prime rate, a key benchmark for other rates, such as credit cards. (Tuesday, at least one -- Bank of America -- raised its prime rate to 9% from 8.75%.)
But for many other types of interest rates, the Fed's influence is far more indirect. Corporate and mortgage rates are priced by investors in the bond market. And while they usually use short-term rates to give them guidance, in recent months bond markets and corporate issuers have been in their own worlds, almost dismissing actions by the Fed.
It isn't that the Fed rate increases are having no impact. Market watchers say they are a contributing factor to higher issuance costs and the weak issuance across debt markets that prevailed until this month -- but only a contributing factor. Factors including stock-market and bond-market volatility, credit concerns and mutual funds' cash intakes have had a bigger impact than the Fed on bond issuance lately. And if those factors were to fade, debt issuance could strengthen, throwing new fuel on an economy the Fed believes is overheated.
Rather than halt their plans, companies finding interest rates too steep in one market have often been able to turn to other markets for capital. FelCor Lodging Trust Inc. in January canceled a $200 million junk-bond deal intended to fund a stock buyback, citing steep interest rates; the Irving, Texas, company had planned on getting 10.25%, but the market demanded 11%.
So FelCor instead lined up a $145 million mortgage-debt transaction with an insurance company, at a rate of less than 9%, cheaper than it could have issued the junk bond for. The postponement of the bond deal "didn't affect us one bit at all," said Thomas J. Corcoran, Jr., president and chief executive officer of the firm.
On top of the interest-rate fluctuations, there have been wide swings in spreads, or the difference between the yield of benchmark Treasury bonds and the yields paid by corporate bonds.
Providian Financial Corp. in February pulled a $250 million junk bond. Were the rates too high? Nope. "Our decision to postpone didn't have anything to do with interest rates," says a spokeswoman for the San Francisco company. "The spread wasn't what we wanted it to be. At the time in financial services, there was some turmoil on the equity side, which was spilling over into the fixed-income side."
The investment-grade bond market has been more affected by credit-market volatility than by rising rates. The volatility has been driven by sharp swings in the stock-market valuations of investment-grade issuers, by the decreasing supply of 30-year Treasury bonds as the government buys them back, and by volatile interest-rate swaps spreads.
In junk bonds, rising rates are having an impact. Some companies with single-B ratings that two years ago could have issued junk bonds at 9% are now facing 13% plus a need to contribute equity warrants. While higher interest rates are easier for telecommunications and technology companies to brush off, Old Economy manufacturers and leveraged buyout funds are far more sensitive.
But market watchers said junk-bond rates are higher mostly for reasons other than the Fed. Investors have demanded far higher yields since Russia's August 1998 financial meltdown triggered a U.S. credit crunch. Junk, or high-yield, bonds have also been hurt by weak demand due to mutual-fund selling, and by a surge in bond defaults. Money has flowed out of junk-bond funds for 16 of the past 20 weeks, with a whopping $2.45 billion flowing out of these funds so far this year, according to AMG Data Services.
At this point, there is no evidence that companies are holding back from investing because of the lack of funds, said Adrian Kingshott, chief operating officer for global leveraged finance at Goldman Sachs Group Inc. Even with weakness in junk bonds, companies can tap a range of other financing options, including mezzanine capital, syndicated loans and private debt placements. "These companies aren't starved for capital," Mr. Kingshott says.