A Little about Bonds and Corporate Bankruptcies

Published Wednesday, November 18, 2009 @ 10:30 am

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In the last year, we’ve been witness to one record breaking bankruptcy petition after the next, from national retailers like Circuit City to automobile manufacturing icons like General Motors. However, in the last few months, fewer companies have failed thanks to the relative loosening of the credit markets and the somewhat more complex process of bond sales and distressed-debt exchanges.

A distressed-debt exchange occurs when bondholders trade, or exchange, current debt for debt that will come due down the road or for equity in the hopefully stronger company, provided the money from the bonds fuels enough positive change.

Okay, and what are bonds? Basically, a securitized loan.

Companies often issue bonds to raise money instead of going to banks for a loan. Basically, a bond is a debt instrument. The issuer (the company) agrees to pay back the holder (the entity loaning the money, like an investor) the principle with interest.

Bonds are often a better way for a company to secure capital because banks are often much too restrictive on how the company can use the borrowed funds. So for large public companies, bonds are often a better way to go when times are tight or some sort of company expansion is planned.

Since the beginning of 2009, companies have issued close to $123 billion in new bonds whereas in 2008, struggling companies issued closer to $48 billion in new bonds.

The money being raised has allowed a number of companies to avoid bankruptcy court. Although, many of those bonds are considered very low quality, or “junk” bonds, because the potential to become insolvent makes it a risky investment.

There are positives to take away from the large amount of money being raised, and that’s the idea the investors see value in the markets and are not nearly as pessimistic as months past.

Detractors of the growth in bond issuance believe that many companies are merely delaying the inevitable and that when the bonds come due, issuers will not be able to pay them. In the next five years, it is estimated that almost $1.4 trillion in bonds will be called due.

Additionally, the majority of the money being raised will be used to refinance existing loans. Typically, bonds are issued to fund expansion efforts, which is what has ignited glimmers of optimism along Wall Street.

An executive for Barclays was able to find some good news in the recent wave of fundraising, remarking that companies are able to avoid “bankruptcies that would have otherwise occurred in the next year.”

Helping the bond market, not that it should surprise many, is the United States government. By keeping interest rates so low, investors are seeking returns on riskier bets, such as junk bonds, instead of more traditional investment vehicles. Bonds are considered a high-yield investment.

A good example of the power of bond sales today is Blockbuster, the movie rental chain and stalwart on every money-saver’s “how-to-have-fun-without-going-out” list. Last spring, the nation’s most prominent movie rental chain was on the verge of having to close the set but by last month, had raised enough by issuing bonds to drastically cut what it owed to banks, raising double what it set out to secure. Let the show go on.

The ability of many of these companies to pay their bonds rests on the potential increase in consumer spending and the general growth of the economy. Will the holiday spending periods do enough to keep things moving in the right direction? Right now, the jury is still out.

But at least corporate bankruptcies are down.

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