The bursting of the late-1990s speculative investment bubble was about more than crumbling tech stocks. Corporate debt defaults contributed more significantly to investor losses than most people think.
Sure, the collapse of Internet stocks destroyed an estimated $670 billion in market capitalization. But because standard practice among the dot-coms that went public during the boom was to float 10 percent or less of their shares, stock market investors lost something closer to $60 billion when the bubble burst.
That’s hardly chump change, but it doesn’t approach the losses suffered by investors who bought the record amounts of non-investment-grade corporate debt issued in the go-go years. U.S. companies defaulted on $216 billion in high-yield bonds from 2000 through 2002, according to Fitch Ratings. With recovery rates sometimes only pennies on the dollar in reorganizations, investors lost far more on these debt securities than on dot-bomb stocks.
The pain from that historic overleveraging is still fresh. Yet corporations and investors again are gorging themselves on high-risk debt. This year through August 11, the riskiest U.S. companies -- those whose debt is deem-ed non-investment-grade, or junk, by credit-rating agencies -- have sold $74.8 billion in bonds, according to New York research firm Dealogic. At this pace, high-yield issuance will set an all-time record in 2003, surpassing the $112.3 billion sold in 1998. In the much larger syndicated loan market, junk-rated companies have raised $213.1 billion this year, a rate also not seen since the hyperspeculative years of 1998-2000 (see graph).
Is all this activity a cause for concern? Market participants say that the latest round of issuance is different. Instead of telecommunications and other companies loading up on leverage to fund overambitious capital spending projects, today’s volume is dominated by opportunistic refinancing from companies looking to lower their interest costs.
“Companies are taking the opportunity to lock in long-term debt at very attractive prices by issuing high-yield bonds and paying off their bank loans,” says Lucine Kirchhoff, head of loan syndicate at Banc of America Securities. That should leave issuers with healthier balance sheets.
Xerox Corp., for example, in June refinanced $3.1 billion in bank debt by issuing $1.25 billion in junk bonds, taking out a new $1 billion bank credit facility and selling $920 million in convertible preferred securities. (Also part of the deal was $472 million in common stock.) The company is saving about 2 percentage points in interest costs on the new debt.
The retirement of so much bank debt has only fueled activity in that market, as institutional holders receive injections of cash that they use to fund new loans.
But the recent boom in high-yield borrowing does pose some risk for both corporations and investors. Refinancing lowers interest costs, but in most cases it doesn’t reduce total debt levels. Consequently, some companies may still be carrying very high debt loads, which can present problems if cash flow suddenly doesn’t meet expectations.
Indeed, there are signs that investors, alarmed by the sharp rise in rates this summer, are losing their appetite for junk. In August high-yield-bond mutual funds saw steady outflows of investor money after enjoying inflows for most of 2003, according to AMG Data Services. Speculative bond issuance, at a little more than $6 billion at midmonth, was off the pace of May ($18.7 billion), June ($16 billion) and July ($14.7 billion). Leveraged loan volume, also $6 billion in mid-August, is running at least 50 percent below recent levels.
However, bankers don’t expect the high-yield financing window to close anytime soon. “In the loan market we seem to have hit a price floor,” says BofA’s Kirchhoff. “But institutions are sitting on a lot of cash from all the refinancing activity. I think there’s still capacity to put a lot of money to work.”
