Companies shed debt, but are they light enough to soar? Experts see need for more cutting

April 11, 1993|By Ian Johnson | Ian Johnson,New York Bureau

New York --As economists try to gauge the strength of the economic recovery, they are stuck with a nagging question: Have U.S. companies shed enough debt to start hiring again?

Everyone agrees that companies have shed some of the debt accumulated during the 1980s takeover and leveraged-buyout binges. But companies are still more bloated than they were before those binges began, new research shows. And most of the debt reduction has come from low interest rates on bank loans -- which may have bottomed out -- rather than from the vigorous stock and bond issuances over the past two years.

"Our research suggests that if businesses want to get back to the old levels of corporate debt that they had, they still have another two to three years to go," said Robert N. McCauley, a staff economist with the Federal Reserve Bank of New York and co-author of a new study on recent corporate refinancings.

A strong recovery may be years away, as corporate executives focus on shedding subsidiaries rather than expanding and creating jobs.

Even if those executives are content to carry a heavy debt load, they are probably a year away from feeling comfortable about their balance sheets.

One example: Towson-based Black & Decker Corp., which was saddled with $4 billion in debt after its 1989 takeover of Emhart Corp. The power-tool maker used a $465 million stock offering last year to cut its debt. But it still carries $2.5 billion in debt and has made debt reduction its top goal, said Treasurer Mike Karsner.

Like many big businesses, Black & Decker was hurt by its debt. The company has had to sell off key businesses such as True Temper Hardware and lay off hundreds of workers in recent years. The debt burden, reflected by a low credit rating, also has made it more difficult -- and more expensive -- for Black & Decker to raise cash by borrowing, Mr. Karsner said.

Black & Decker may be an extreme example, but the New York Fed's study suggests that corporate America is still heavily burdened with debt. The ratio of interest payments to cash flow soared from about 18 percent in 1983 to 24 percent in 1990 at the 600 biggest U.S. companies, the study showed. Since then, the ratio has dropped to 20.5 percent.

That means that the average company made more than 20 cents in interest payments for every dollar of cash flow.

The drop in the ratio, however, came largely through lower interest rates, which lopped off $27 billion in corporate debt. The recent spate of corporate refinancing, by contrast, cut only $2.8 billion.

Although this means that nearly $30 billion in debt has been cut in two years, the trend probably cannot continue at this pace, Mr. McCauley said. Inflation might return after lying dormant for two years, forcing the Federal Reserve to raise interest rates.

"Once the lower interest rates feed through the system completely, that downward slope is going to level off quite a bit," he said. "Then progress will get slower."

One surprising study finding: Refinancings through stock and bond issuances have been relatively ineffective in cutting corporate debt. The Fed estimates that issuing equity to pay off debt -- as Black & Decker did last year -- cut debt by $3.9 billion.

But corporations also have created mounds of new debt in the form of bonds. Last year, a record $153 billion in corporate bonds was issued. Some bonds were used to pay off bonds issued at higher rates of interest, but many have replaced cheaper bank credit.

The wave of new bond issuances cost corporations $1.1 billion over the past two years, helping to limit the impact of the new stock issues.

Consider the costly experience of Wyman-Gordon Co., a Massachusetts aerospace company that issued $90 million in debt last month.

The money, which carries a stiff 10.75 percent interest rate, won't pay off more expensive debt or expand the company's business. Instead, it will be used to pay off less-expensive bank debt, which carried an interest rate of about 6 percent. Assuming that bank rates stay at current levels, the cost to Wyman-Gordon over 10 years could reach $5 million.

Chief Financial Officer Luis E. Leon said the company made the sacrifice to avoid having to deal with the banks and to lock in low rates for junk bonds rated BB.

"We thought this was a good opportunity that we couldn't pass up," Mr. Leon said.

L "It consolidated everything, even if it was more expensive."

Others, however, saw different motives behind the debt issue.

"The banks wanted out," said Richard Lehmann, president of the Bond Investors Association, which warns against buying Wyman-Gordon's new bonds.

"Nobody in their right mind is going to do this voluntarily, but they were forced into it."

Not all companies are losing money when they issue debt. Many hope to save money by replacing high-interest junk bonds.

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