Borrowing costs are hurting firms’ recovery efforts

The highest inflation-adjusted borrowing costs since the 1980s are hindering companies’ ability to build their businesses.
Customers of Airgas Inc. are reducing purchases of industrial gases such as nitrogen and acetylene because of rising real interest rates, said Chief Executive Officer Peter McCausland. Real rates account for inflation or deflation.
“There is no question” high real rates have aggravated Airgas’s sales decline, he said in an interview.
The climb in rates “really reflects a risk aversion,” said David Rickard, chief financial officer of Woonsocket-based CVS Caremark Corp. “People are afraid to lend.”
Annualized consumer prices fell by 0.4 percent in March, the first decline in 54 years, and Treasury yields jumped to a five-month high. That pushed real investment-grade corporate borrowing costs to 8.34 percent, the highest level since 1985, according to data compiled by Bloomberg and Merrill Lynch & Co. Price declines accelerated in April to 0.6 percent, according to 28 economists surveyed by Bloomberg.
Rising real yields may deter companies from borrowing to invest in new products or factories because deflation will erode cash flow and make it harder to service debt, said John Lonski, chief economist at Moody’s Capital Markets Group in New York.
“That’s almost guaranteed to delay an economic recovery and perhaps very much risks intensifying the current economic slump,” Lonski said in a telephone interview.
“Deflation hurts borrowers and rewards savers,” said Drew Matus, senior economist at Banc of America Securities-Merrill Lynch in New York, in a telephone interview. “If you do borrow right now, and we go through a period of deflation, your cost of borrowing just went through the roof.” The last time Americans experienced deflation was when former President Dwight Eisenhower resided in the White House and the Disneyland theme park first swung open its gates in Anaheim, Calif. The Consumer Price Index declined for 12 straight months beginning September 1954.
Surging refinancing costs are forcing Energy Transfer Partners LP to cancel or avoid pipeline projects that don’t offer returns above 20 percent, Chief Financial Officer Martin Salinas said in an interview. Debt yields have been 2 to 3 percentage points higher than what the Dallas-based company has been used to, he said.
Energy Transfer, the third-largest U.S. pipeline partnership by market value, in April raised $650 million for capital expenditures and to repay bank debt by offering investors a 9 percent interest rate on 10-year bonds, Bloomberg data show. While 0.7 percentage point lower than what the company paid for similar debt in December, the coupon was 2.3 percentage points higher than an offering a year earlier.
“There is definitely some sticker shock,” said Salinas. “We can’t build the project if we can’t cover our cost and get a return on it.”
While the gap between investment-grade bond yields and rates on similarly maturing Treasuries narrowed 158 basis points in the past two months, a jump in benchmark yields and deflation erased most of the improvement, meaning real rates are still near their highest levels since 1985.
“Real interest rates are going up,” said McCausland of Radnor, Pa.-based Airgas.
Yields on the benchmark 10-year Treasury soared to 3.34 percent on May 7, the highest since Nov. 18, from a record-low 2.06 percent at the end of 2008. The Consumer Price Index fell an annualized 0.4 percent in March, and economists surveyed by Bloomberg forecast a 0.6 percent drop for April. That would put real yields on investment-grade bonds at 7.91 percent last month compared with 8.34 percent in March, the highest since April 1985.
The drop in consumer prices is a “double whammy” for retailers, said Patricia Edwards, a retail analyst at Storehouse Partners LLC in Bellevue, Wash. That’s because consumers cut spending and the quality of products they buy, meaning lower prices and sales. “For those who don’t have their funding nailed down, that’s where the hurt is going to be,” she said.
CVS, the largest U.S. drug-store chain, has been relying on short-term commercial paper to finance the construction of new stores after the long-term sale lease-back market it typically used for the investments “disappeared” in October 2008, Rickard said. Companies learned the risks of relying too heavily on commercial paper after the market froze in September 2008 following the collapse of Lehman Brothers Holdings Inc.
When the sale lease-back market began to recover toward the end of 2008, nominal interest rates of about 14 percent were “too much to saddle us with for 20 to 40 years” on $600 million of needed financing, Rickard said.
“I deferred that financing and we muddled through using commercial paper,” Rickard said. “As people gain more confidence I believe real interest rates will begin to come down and we will get – not back to where we were in June, July and August of 2008 – but closer to there than we are today.” &#8226