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Corporate bond issues totaled $ 245 billion in March, up from $ 139 billion a year earlier. In April, that number rose to $ 316 billion. In the first five months of 2020, as companies attempted to offset sharp declines in income with borrowing, total corporate bond issuance rose to over $ 1 trillion.
But many businesses have not been able to borrow money to extricate themselves from falling incomes. And, as new research paper shows, these companies saw larger share price declines during the COVID-19 crisis.
So how can companies prepare in good times to be able to access capital markets in bad times?
On one level, the answer is simple: maintain financial flexibility by maintaining low leverage and a high credit rating. But it’s easier said than done. After all, in order to do this, companies may have to restrain their growth and forgo business opportunities.
Fortunately, there is another very important aspect of financial flexibility that businesses can manage: avoiding secured debt when possible. For businesses, pledging assets as collateral for secured debt limits their ability to pledge those assets when they need them most, such as during a financial crisis or global pandemic.
In a recent study We have found that most companies in the United States issue secured debt counter-cyclically and are more willing or obligated to issue them at the trough rather than at the peak of a cycle. Borrowers do not seem to want to lose their financial flexibility by pledging assets in a timely manner. Instead, they only use the security when it’s needed, when a business is approaching distress, or during the bearish phase of a cycle, which explains the countercyclical nature of secured debt issuance.
The idea that untapped collateral could offer companies financial flexibility in times of crisis is not new – it is even an important factor in some credit scoring models. For example, Moody’s has pointed out that “mortgage-free real estate is an alternative source of liquidity through the issuance of real estate-specific mortgage debt, or even sales” – and in fact assigns a lower credit rating to real estate. companies with higher ratios. from guaranteed debt to gross assets.
Yet time and time again, companies leverage their collateral when times are good and times are hurting. Take United Airlines, which ended 2019 with 88.5% of its $ 14 billion long-term debt secured by the privileges of its new aircraft. When the COVID-19 crisis hit, United rushed to raise additional funds. With a lower investment grade credit rating of BB-, United was unable to borrow without collateral. So she tried to borrow through a term loan secured by liens on her old plane. United were so desperate to raise additional funds that they had to raise $ 500 million by guaranteeing liens on certain aircraft spare parts they owned and an additional $ 250 million guaranteed by spare engines. When United attempted to raise new funds in early May, their $ 2.25 billion bid failed when investors deemed the collateral too old and priceless – United had very little collateral capacity.
This contrasts with Delta Airlines, which at the end of 2019 had less than 50% of its $ 10 billion long-term debt secured by assets. At the start of the crisis, Delta was able to issue a $ 1 billion bond guaranteed by five Airbus A321s, 22 Boeing 737s and six Airbus A330s worth $ 1.47 billion. And Delta was also able to issue an unsecured bond and raise an additional $ 1.25 billion at the end of May.
Interestingly, many of the bonds issued in the past three months were unsecured. But these bonds were issued by companies with an investment grade rating, such as Disney ($ 11 billion) or Boeing ($ 25 billion). For businesses with a lower credit rating, the only reasonable option is often to resort to secured loans. Only $ 37 billion in high yield bonds were issued in May 2020, compared to $ 265 billion by quality companies. And these high yield bonds are much more likely to be backed by assets than higher quality bonds.
The lesson for business is therefore clear. Avoid timely secured debts in order to maintain collateral capacity and financial flexibility. Keep your unused assets, you might need them in the next crisis.
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