When Corporations Buy Corporate Bonds

With yields so low, many companies have been gobbling up short-term corporate bonds in lieu of cash. But what happens as rates rise?

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Chris Ratcliffe

When it comes to putting their massive cash reserves to work in search of a decent return, U.S. companies are helping one another out by buying the bonds of their brethren.

Some 52.7 percent of the cash held by publicly traded, nonfinancial companies was invested in those securities as of January 1, according to Clearwater Analytics. Nonfinancial companies in the Standard & Poor’s 500 index held $1.45 trillion of cash and short-term fixed-income investments at the end of the third quarter, according to FactSet Research Systems.

“Corporations are creating more cash than investment opportunities” as they shy away from capital expenditures, says John Majoros, a portfolio manager for fixed-income money management firm Wasmer, Schroeder & Co. in Cleveland. “They have to do something with their money” in a low-yield environment. So, many are opting for short-term investment-grade corporate bonds, those with maturities of five years or less.

Other factors behind the trend include increased capital requirements for banks, which have them turning away corporate deposits, as well as new regulations for money market funds, scheduled to begin in October, that will require the funds to adopt floating net asset values. Consequently, funds’ share prices can drop below $1, making them less attractive.

Companies with huge corporate bond positions include Cupertino, California’s Apple, with $99 billion as of last year; Redwood Shores, California–based Oracle Corp., with $29 billion; and Amgen, in Thousand Oaks, California, with $16 billion.

The strong corporate demand for short-term corporate bonds, especially those rated single-A, is helping to keep yields down in that portion of the curve. “The corporate buyers are coming into conflict with traditional buyers — short-duration bond funds,” Majoros says. “Now there is more competition for float.” A two-year, single-A corporate bond yields 1.22 percent, according to Valubond Securities.

That still represents an attractive yield for companies stuck with yields below 1 percent on their cash holdings during the past seven years.

The heavy demand from companies certainly gives their brethren more incentive to issue debt with short maturities. But issuers are more interested in borrowing for longer periods, with long-term rates still low, so they don’t have to pay back the money as quickly. “Some issuance is going to come in that [short] part of the curve, but that’s not part of what CFOs will want to do,” Majoros says. Much of the short-term debt being snapped up by companies consists of old bonds that formerly had long maturities.

Companies with the biggest cash holdings — those in the Fortune 100 — buy longer-term bonds too. “Their fixed-income portfolios may start to resemble more that of an endowment,” says Benjamin Campbell, CEO of Newton, Massachusetts–based Capital Advisors Group, which counsels companies on cash management. He thinks the biggest companies ultimately will get into high-yield and emerging-markets paper too. “They have to participate in all sectors of the market.” The conservatism that companies exhibited with their balance sheets after the 2008–’09 financial crisis clearly is a thing of the past.

Obviously, if interest rates rise, companies buying corporate bonds will see the value of those holdings drop. As long as companies are buying investment-grade bonds and can hold them until maturity, however, the bond purchases shouldn’t cause problems, analysts say. “Buyers would likely shorten the duration of their exposure, but I don’t think they would abandon it,” Campbell says.

Most analysts say the trend of heavy buying will probably continue as long as economic growth stays modest. “Investors will seek the best return they can generate,” says Henry Peabody, a bond portfolio manager at Boston money management firm Eaton Vance.

Yet he and his colleague believe the economy is stronger than consensus forecasts, which call for 2 to 2.5 percent growth, and that could lead to sharp increases in short-term interest rates. Such a rise could result in companies’ boosting their capital expenditures, hoping to beat the rise in rates. Elevated capex, of course, means less cash would be available for buying corporate bonds. “It’s hard to imagine that with the remainder [of the cash], they would ignore bond buying,” Peabody says.

But for the bond market as a whole, it may be more important that the buying is shrinking rather than continuing, Peabody says. So the effect of the corporate bond buying may soon diminish.

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