Does the current appetite for corporate bonds suggest a new risk paradigm?
Reading today’s “Heard on the Street” feature in the Wall Street Journal about spreads on IBM’s recent three-year, $1.5bn debt issue narrowing to 25bps over Treasuries, and selling for a rate of 1 percent, reminds us, if memory serves, of a meme that circulated in European treasury circles during the ‘90s It sought to make the case that high-quality corporate paper was indeed better than a lot of government paper—at least on a risk/return basis.
Now, with the IBM news, followed by record-setting deals from McDonald’s and Wal-Mart, this meme looks set for a revival. Non-financial corporate bonds were already the beneficiaries of the financial crisis lessons about the true quality of high-rated financial institution paper. More recently, concerns over sovereign debt, coupled with a sustained low-rate, if not deflationary environment, have only helped to create conditions to nourish the theme that corporate paper (some, not all) is best.
Treasurers can add to the meme
Of course, one major difference between the creditworthiness of corporates and sovereigns is that sovereigns (at least most, and especially the US) can print money to repay debt denominated in their own currency.
Sovereigns can also impel new cash flow via taxes. Thus, default risk is de minimis. Apart from this, if investors look at the balance sheets of blue-chip corporations and the quality of their financial management, compared to almost all sovereigns, the blue-chip corporations come out way ahead (printing money is rarely seen as a sound financial move). Indeed, some market economists have pointed to the lack of capital market experience currently at the US Fed/ Treasury, for example; and this could prove detrimental to how the US manages its still ballooning balance sheet and the eventual roll off of assets.
Obviously, better financial management and capital market prowess is true of some corporates more than others. Another lesson from the crisis is that individual names and credit analysis at the CUSIP level is critical—no longer can you rely on ratings or traditional thinking about sector risk. Thus, when the quality of sovereign finances deteriorate, corporates can distinguish themselves further by employing better financial management—including squeezing out inefficiencies and cutting costs.
Treasurers can add to the story, too, by being guardians of sound balance sheets, talking up their financial position with investors and taking advantage of funding windows that cause people to compare their financing ability favorably to that of sovereign counterparts. In other words, by being better treasurers they support a meme that works to their advantage. And, fortunately, relative to their sovereign peers, most corporate treasurers look really good.