Companies in the U.S. and Europe are buying back bonds to reduce the cash piles they built up earlier this year, signaling expectations for more stable economic times ahead. Telecom company AT&T Inc., T 5.84% beer brewer Anheuser-Busch InBev SA and oil major BP BP 1.71% PLC are among the firms redeeming debt early after determining that the billions of dollars and euros they raised in response to the turmoil in markets earlier this year isn't likely to be needed. "The world still isn't perfect, but there's more visibility. A lot of companies who have overfunded, they sat there after a few months and said we don't actually need all of this money," said Frazer Ross, a regional head for Deutsche Bank's investment-grade debt syndicate. "It's like they took out an insurance policy, but now it's too costly." This year has seen a 40% rise in the value of bonds bought back early by investment-grade firms in the U.S. and a 50% increase in the region that includes Europe, the Middle East and Africa, compared with last year, according to research from Deutsche Bank. Corporate debt issuance hit an record high in 2020, data from Dealogic showed. In the U.S., firms tapped the bond market for close to $1.5 trillion through September. Companies in Europe raised €486 billion, equivalent to $573 billion. Many firms rushed to set aside the money as a cushion, in anticipation of a prolonged disruption to their operations during the pandemic. AB InBev BUD 1.04% issued seven bonds in April, raising over $11 billion, according to FactSet. British American Tobacco BTI 0.54% PLC sold 11 bonds in the second and third quarters for close to $9 billion. As oil prices fluctuated the most in six years, BP raised over $20 billion of debt. 

But in Europe's ultralow interest rate environment, sitting on excess cash is expensive. The eurozone has had negative interest rates since 2014 and the policy rate is currently set at minus 0.5%. The Bank of England has its benchmark rate set at an record low of 0.1% and is also considering cutting it below zero. That means companies that raised capital from bond sales are often having to pay to keep the cash at their European banks while also disbursing coupon payments to debtholders. "This liquidity amount was higher than we require to manage our business, even in times of elevated volatility," said Fernando Tennenbaum, chief financial officer of AB InBev. "We will continue to proactively manage our upcoming liabilities as we monitor the evolving market environment." His company has undergone two rounds of bond redemptions in the third quarter amounting to a total of $11.5 billion. This includes both tender offers to buy back its outstanding debt and exercising call provisions, which are a clause that allow an issuer to pay off bonds early.

In the U.S., the Federal Reserve has also cut rates, but not that low. While companies may not have to pay to store it, holding on to excess cash unnecessarily still isn't considered to be an optimal use of capital, analysts said. There have been recent signs of the economic rebound slowing around the world. A gauge of the health of the eurozone's services industry through purchasing managers' indexes contracted last month. In the U.S., the recovery in the labor market showed signs of decelerating with last Friday's jobs numbers coming in below economists' expectations. Despite this, credit markets have remained relatively stable due to central bank action. The European Central Bank recently ramped up its purchases of corporate debt. The Fed is set to release minutes on Wednesday from its meeting last month after which it signaled an intent to keep rates low for years. "The thinking by a lot of companies is that they can always raise money again later, if things get bad again," Mr. Ross said. "Central banks are expected to keep borrowing costs low.

Questions:

a) What factors are driving the early redemption of debt?

b) Compare and contrast the interest rate environment in the US and Europe and how this might impact Chief Financial Officers' perspectives on capital structure.

c) Should the increase in bond redemptions be viewed as a positive sign vis a vis an economic recovery?

Answer rating: 100% (QA)

a The factors driving the early redemption of debt include 1 Improved economic outlook Companies may redeem debt early if they anticipate more stable economic conditions and a reduced need for excess ... View the full answer