(The Baltimore Sun posted the following column by Jay Hancock on its website on May 21.)
BALTIMORE — Like many of us, CSX Corp. borrowed boxcars of money in the 1990s.
Loans to buy a piece of Conrail helped double CSX’s annual interest expense to $520 million from 1996 and 1999 and at one point drove its debt-to-capital ratio, including off-books liabilities, up to 63 percent, a level past what many consider risky.
Happily for CSX, its shareholders and the economy, corporate America is gorging at the same financial gravy train that has fed homeowners the past two years. The descendant of the Baltimore and Ohio Railroad refinanced hundreds of millions in debt last year, including $600 million borrowed through the bond markets at rates that once would have been considered fantastically low.
CSX sold $400 million worth of 10-year bonds at 6.3 percent, a once unheard-of coupon for a company whose credit is rated, as CSX’s is, just above “speculative.” Then it turned around and issued another $200 million in seven-year paper at 4.9 percent, said Fredrik J. Eliasson, CSX’s investor relations director.
The flood of liquidity from the Federal Reserve and bond-crazy investors that has brought mortgage rates to 40-year lows has also alleviated the 1990s hangover for many companies.
“Corporate America, shall we say, has committed some pretty egregious sins in the last five years,” says Mark Vaselkiv, who, as skipper of T. Rowe Price’s High Yield Fund, has been helping stoke the refi party. “I think they’ve repented of that behavior and they’re moving back toward a more prudent and more conservative approach to financial management.”
Repentance is easier when bond investors are inclined to absolve.
Corporate bond issuance hit $206 billion in the first quarter, up from $120 billion in the fourth quarter and beating even the bumper $201 billion from the first quarter of 2002, according to Standard & Poor’s. Corporate borrowing has stayed brisk since then, including for the companies that really need loans — the ones with bad credit ratings.
Recent issues of high-yield “junk” bonds by companies with less-than-beautiful balance sheets include flotations by Vivendi Universal, Crown Cork & Seal and Dole Food.
For high-yield bonds, “the market had been trading like the world was coming to an end,” Vaselkiv said. “But, remarkably, it turned — and it turned really hard. The lowest-quality high-yield bonds have had the biggest run.”
Vaselkiv’s fund has returned 10.6 percent since the beginning of the year and taken in some $400 million in new money. His winning buys include bonds by Nextel, which hit a low of less than 70 cents on the dollar and then popped above face value, and AES Corp., which fell as low as about 35 cents before rising to about 90 cents.
Investors’ swarm to corporate debt and especially junk bonds has been driven by a scary stock market and paltry yields in Treasury notes and money-market funds.
Plenty of people, including Warren Buffett, have suggested that junk bonds are fairly priced or overpriced at current levels. But the point is that, for whatever reason, people are lending money at low rates like gangbusters to corporate America, giving many companies a chance to refinance and repair balance sheets.
The yield on a junk-bond index tracked by KDP Investment Advisors dropped below 9 percent recently from more than 12 percent last year. Long-term bonds for top-rated companies yield well under 5 percent.
It might be nice to report that the proceeds of all this borrowing are being spent on hiring workers, buying computers and building factories. But they aren’t. They’re largely refinancing existing debt, especially short-term obligations that threatened to blow up when the financial markets were feeling less generous.
Studies by Merrill Lynch’s Richard Bernstein show that post-recession business investment perks up only after companies have made substantial improvements to their damaged finances, and he thinks this process isn’t nearly over.
It’s not over for CSX. The railroad cut its interest expense by $73 million last year compared with 2001 and saved another $11 million in interest costs in the first quarter. The company is profitable, and it just got a cash infusion from the sale of an affiliate — but it’s keeping capital investment on the lean side. Instead of spending the money, it plans to keep cutting debt, which was down to 55 percent of capital at the end of March.
“We are going to continue to apply cash toward debt reduction until we get to approximately 50 percent,” says Eliasson. After that CSX will buy back stock or raise its dividend, he added.
So maybe we won’t see a jump in hiring and investment this year. But we’re laying a foundation for one.