BHP call makes baby-boomer sense
The first view is short term. Like other top corporations, BHP is paying more for debt that it did a year ago, or even a few months ago. You might like to blame the US Federal Reserve, but in fact you shouldn't blame anybody: rising rates are an appetiser on an economic recovery menu, as long as they don't get out of hand.
The second view is long term, and by long term I mean baby-boomer long term. Boards are stuffed with baby boomers. They remember what steep borrowing costs look like, and know they don't look anything like this.
They know too that five years from now the markets will probably be rewarding companies that took advantage of the cheap money while it lasted, and are carefully backing their intuition. BHP's latest raising is, for example, loaded with long-dated debt that locks in lower debt-servicing costs.
BHP is issuing $US500 million worth of three-year floating-rate notes that will yield a quarter of a percentage point more than the 90-day US-dollar London interbank (Libor) lending rate. The US-dollar Libor rate is currently 0.25 per cent, so that dough has a start-up debt-service cost of 0.5 per cent a year.
It has raised another $US500 million with five-year notes priced at 2.05 per cent, and has raised $US1.5 billion with 10-year notes that pay 3.85 per cent.
By far the biggest whack, $US2.5 billion, or 50 per cent of the total amount raised, has been slotted away for no less than 30 years, at a rate of 5 per cent.
Corporate debt is more expensive than it was recently. In February last year, for example, BHP raised $US5.25 billion, including $US1 billion of 10-year money at 2.875 per cent, and another $1 billion of 30-year funding at a rate of 4.125 per cent.
Comparisons become more difficult when money is raised in different currencies because it costs money to swap it, but the group also paid 3.23 per cent for 750 million Canadian dollars over 10 years in May this year, and 3.125 per cent over 10 years in April for €750 million.
The increase basically reflects the fact that the global economy is in better shape. Concern that Europe's sovereign debt crisis would reignite the global crisis were escalating when BHP approached the debt markets in February last year, and did not peak until late July, when European Central Bank President Mario Draghi delivered his "what it takes" statement, the market's equivalent of Dirty Harry's "go ahead - make my day" line.
The US Federal Reserve's warnings since April that it is preparing to phase out its $US85 billion-a-month quantitative easing program is a component of the recovery trend. The QE taper didn't begin this month as most expected, but it will start soon; and when it does, liquidity will tighten. Yields and rates have already moved up in anticipation.
Boardroom baby boomers know, however, that corporate loan money is still cheap by historical standards. Since the global crisis hit, top-grade corporations have been a lending safe harbour.
BHP's latest 10-year rate of 3.85 per cent compares, for example, with a Spanish 10-year government debt yield of 4.28 per cent, and a yield of 3.88 per cent on AAA-rated 10-year Australian government debt (BHP 's 10-year tranche would cost half a percentage point more than that if it were swapped from US dollars to Australian dollars, but it probably won't be).
Corporate borrowing rates are back to where they were in the 1950s, and about a third of what they were as central banks struggled to squeeze inflation out of the global system in the wake of the OPEC oil price shocks in 1973 and 1979.
A blended corporate bond yield index run by Moody's moved above 4 per cent in 1958, and was above 9 per cent going into the 1973 oil price shock. It went above 10 per cent in 1979, and peaked at 15.49 per cent in 1981. It was back down below 6 per cent by 2003, hit a low of 3.47 per cent in October last year, and is currently 4.54 per cent.
Maybe rates will stay low. History tells us these are unusual times and that money supply injections are inflationary. The global crisis has resulted in the mother of all money injections, and highly rated companies such as BHP are borrowing over longer terms to lock in low rates while they are available. In doing so they buttress profits and the economic recovery.
In February last year, BHP raised $US1 billion over 10 years and $US1 billion over 30 years. Each tranche equated to 18 per cent of the $5.25 billion total raising, and at June 30 this year BHP's debt portfolio had an average term of 7.4 years.
In its latest $US5 billion raising, it has lifted the 10-year tranche to $US1.5 billion, but it is the leap from $US1 billion to $US2.5 billion over 30 years that is the big call: by the time it is embedded, the average tenure of BHP's debt will have risen to almost nine years.
The Maiden family owns BHP shares.
mmaiden@fairfaxmedia.com.au
Frequently Asked Questions about this Article…
BHP raised US$5 billion split into four tranches: US$500 million of three‑year floating‑rate notes at Libor + 0.25% (Libor was 0.25% at the time, giving a start‑up cost of about 0.5% p.a.), US$500 million of five‑year notes priced at 2.05%, US$1.5 billion of 10‑year notes at 3.85%, and US$2.5 billion of 30‑year debt at 5%.
BHP is locking in long‑dated funding while rates are relatively low. The article explains boards (described as ‘baby‑boomer’ boards) prefer to secure long‑term, predictable debt‑service costs, expecting that companies that took advantage of cheap money will be rewarded as the economy recovers.
Corporate debt is more expensive than it was a few months earlier, but still low by historical standards. For comparison, in February last year BHP raised US$5.25 billion including US$1 billion of 10‑year money at 2.875% and US$1 billion of 30‑year funding at 4.125%.
A floating‑rate note pays interest that moves with a reference rate (here the 90‑day US‑dollar Libor). At the time of the deal Libor was 0.25%, so Libor + 0.25% implied an initial cost of about 0.5% per year. For BHP it provides short‑term funding with interest that adjusts as market rates change.
At 30 June BHP’s debt portfolio had an average term of 7.4 years. By increasing the 30‑year tranche from US$1 billion to US$2.5 billion, the company’s average debt tenor will rise to almost nine years once the new issuance is embedded.
Yes. The article notes corporate borrowing rates are back to levels seen in the 1950s and are far lower than in the 1970s–1980s. It cites a Moody’s blended corporate bond yield index: above 4% in 1958, over 9% in 1973, peaking above 15% in 1981, falling below 6% by 2003, hitting a low of 3.47% in October last year, and being 4.54% at the time of the article.
Yes. The article warns that comparisons are harder when debt is raised in different currencies because it costs money to swap currencies. It also gives examples: BHP paid 3.23% for C$750 million over 10 years in May and 3.125% for €750 million over 10 years in April. It notes the US$10‑year tranche would cost about 0.5 percentage points more if swapped into Australian dollars, though it probably won’t be.
Yes. The article discloses that the Maiden family owns BHP shares, which is a declared interest in the company.
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