fed trapped..can't raise rates..why will will have massive inflation...
Companies May Hide Risks, Gross Says: Rates of Return
New York April 10 (Bloomberg) -- U.S. companies are making it difficult for investors to judge their exposure to rising interest rates by exchanging fixed-coupon obligations for those that rise and fall with changes in the economy, Bill Gross, manager of the world's largest bond fund, said.
Although the tactic can lower borrowing costs in the short term, companies ``are truly taking an open-ended risk of loss,'' the manager of Pacific Investment Management Co.'s Total Return Bond Fund, said in a commentary on the Allianz AG unit's Web site.
The added risk isn't clear to investors because the so- called interest-rate swaps don't show up in company financial reports, he said.
``Try finding these swaps detailed by amount and purpose in a 10K or annual report,'' Gross wrote. ``Even Sherlock Holmes couldn't find something that wasn't there.''
Kerr-McGee Corp. is one of the latest companies to lower its borrowing costs this way. The Oklahoma City-based oil and gas company raised $350 million yesterday, then cut its financing costs by swapping its newly issued three-year notes for floating- rate obligations.
The fixed-rate notes it sold carried a coupon of 5.375 percent. It exchanged them for obligations with a rate 87.5 basis points above the benchmark London interbank offered rate. As a result, the company's borrowing cost would exceed the 5.375 percent coupon should Libor rise to 4.5 percent or above. A basis point equals 0.01 percentage point.
Expected Savings
Kerr-McGee expects to save about 3 percentage points on the proceeds in the first year, Chief Financial Officer Robert Wohleber said. Excluding costs, that would work out to a savings of about $10.5 million. The swap also helped the company maintain its goal of keeping 25 percent of total debt as floating-rate obligations because it paid off commercial paper, he said.
Should rates start to rise, turning the debt back into a fixed-rate obligation ``is a possibility,'' Wohleber said.
Interest-rate futures indicate traders see three-month Libor rates more than doubling to above 4 percent next year from the current 2 percent.
Gross didn't mention Kerr-McGee. He didn't return calls for comment.
Interest-rate swaps traded through U.S. banks totaled about $27.84 trillion during the fourth quarter of 1999, according to a report from the Controller of the Currency, a unit of the Treasury Department.
Treasurer's Dilemma
Some others share Gross's concern. While companies ``are keeping an eye on their immediate profitability,'' they are subjecting themselves ``to a lot of exposure to short-term rates,'' said Frank Waung, an economist at Societe Generale in New York.
It also is an issue for some corporate treasurers. Apache Corp. sold $400 million of 10-year notes on Monday and is still considering its options, said Matt Dundrea, the company's treasurer.
Swapping the whole 10-year note into a floating-rate obligation would save about $12 million in interest costs during the first year, based on projected interest rates, Dundrea said. On the other had, he added, ``If as a result of an upswing in the economy short-term rates spike, then you're better off staying'' with the fixed coupon payments.
Traders and economists are predicting the Fed will increase the so-called federal funds rate by a quarter-point to 2 percent when it meets in June. Last year's 11 interest-rate cuts sent the fed funds target to a 40-year low, sparking a 10-month bond rally that prompted companies to sell longer-term debt.
Widening Gap
The difference between the Fed's target and the 10-year note rose as high as 3.68 percentage points this month, the widest since 1996, making it cost effective for companies to increase their reliance on debt based on short-term interest rates.
The large gap between the Fed's target and Treasury note and bond yields, used as a base for corporate debt sales, means companies pay a penalty for selling longer-term securities, Waung said. They alleviate it by exchanging the fixed-rate bond payments for floating-rate payments.
Companies sold a record $800 billion of notes and bonds in 2001 and another $178 billion in the first quarter of this year, partly to repay short-term debt and partly to lock in borrowing costs in anticipation of higher rates. Those borrowings typically show up on corporate balance sheets as long-term debt with locked in rates, even in cases where they have been exchanged for floating-rate obligations subject to rising interest rates.
``The consequence is corporate America's profitability is exposed to the fed funds rate more than the capital structure would lead you to believe,'' Waung said.
$11 Billion Offering
General Electric Capital Co., the financing arm of General Electric Co., sold $11 billion of notes last month to reduce its reliance on unsecured short-term debt. The company swapped some of that debt into floating-rate obligations, wrote Gross, who took aim at GE last month for its lack of transparency.
GE Capital last year paid an average of 3.23 percent on the long-term debt it swapped into floating rate obligations, according to a company filing. At year-end, its commercial paper, unsecured debt maturing in less than nine months, and other short- term debt cost an average of 2.56 percent, the filing said. The 10-year Treasury note, a benchmark for corporate borrowing, yielded an average of 5 percent last year.
The last time the central bank raised interest rates was between June 1999 and May 2000 when it took the fed funds rate to 6.5 percent from 4.75 percent. That increase ``was a factor in causing a mild recession in 2001,'' Gross wrote. |
