Corp Credit--Why Terming out debt?
Hi All, recent joiner to a credit desk here, just am coming across things day to day I feel I'm missing and was hoping someone here could explain to me in layman's terms because its not clicking: why would an issuer go out issuing longer-term debt today? Am I just overthinking it that they just won't have to repay the principal in 30 yrs vs. in 5yrs? From the trading standpoint it just seems more risky as longer end debt is more duration sensitive, but is it just that the issuer won't care about that and they're just thinking money borrowed vs. paid back in 30y vs. in 5y? What other considerations are there that issuers would think about?
Ah, welcome to the jungle of corporate credit! It's like swinging through the trees in the finance forest – thrilling but you gotta watch out for the tricky branches. Let's break down why a company might decide to issue longer-term debt, in terms even us monkeys can understand.
Longer Leash on Repayments: Just like you guessed, issuing longer-term debt means the company doesn't have to worry about repaying the principal for a longer period. It's like choosing a longer vine to swing on; you've got more time before you need to grab the next one.
Locking in Rates: In times when interest rates are low, companies might issue longer-term debt to lock in those low rates for an extended period. It's like finding a bunch of bananas at a low price and stocking up to enjoy them for longer.
Predictable Payments: Longer-term debt gives companies a clearer picture of their future payment obligations. It's easier to plan your route through the forest when you know exactly where the vines are and how long they'll last.
Investor Appeal: Some investors prefer the potentially higher yields and the perceived safety of longer-term debt, especially if they're looking to match long-term liabilities. It's like offering a longer, sturdier branch to those who are planning to stay in the tree for a while.
Financial Flexibility: By terming out debt, companies can improve their liquidity and financial stability in the short term, giving them more room to maneuver, invest, or handle unexpected downturns. It's like having a stash of bananas for emergencies – it just gives you more options.
From the issuer's perspective, the increased duration sensitivity and potential for higher interest costs over the life of the bond are often considered worth the trade-off for the benefits of having longer to repay the debt and locking in favorable interest rates. They're focused on navigating the financial forest as efficiently as possible, not necessarily on the day-to-day swings in bond prices that traders might worry about.
So, in the grand scheme of things, it's not just about delaying repayment. It's about strategic financial planning, managing risks, and making the most of the current economic environment. Keep swinging through those trees, and you'll get the hang of it!
Sources: Overview of Leveraged Finance, Overview of Leveraged Finance, Rational behind a lender choosing a loan term, January 2016 Data Update 6: Debt, the double edged sword, LBOs - Why repay debt instead of keeping cash flow?
If you buy a bond, you are long duration risk, obviously. For the issuer, it's the exact inverse, they are short duration risk. The longer the tenor of debt issued, the more interest rate risk the issuer has shifted from itself to the buyer of the debt. From the issuer's perspective, it's more often than not favorable to term out debt, especially if you think interest rates will rise.
What stops issuers from terming out debt ad infinitum is the investor base at some point will refuse to absorb that much duration risk and will either 1) not buy any more debt at all 2) demand significantly more interest to offset the duration risk.
An issuers ability to term out debt is heavily governed by marker demand for such debt and how much they are willing to hold at the interest rate the issuer is willing and able to pay
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