Investment bankers may owe the Fed even greater gratitude for their vacation houses than previously thought. For years, bond purchases, or quantitative easing, by the Federal Reserve pushed down interest rates. That nudged investors into all sorts of risk assets in order to find yield.
A new study from the Federal Reserve Bank of New York quantifies one unintended consequence — the issuance of trillions of dollars of bonds by US companies in the BBB credit rating category.
Buyers of investment grade debt searching for yield — often insurance companies needing to meet policy payments — piled heavily into lower-rated investment grade debt. As a result of the surging demand, BBB companies saw lower borrowing costs than higher-rated companies.
The trillions they were able to raise at alluringly low rates were often ploughed into M&A. The acquirers included AT&T, Kraft Heinz and Newell Brands. These dealmaking sprees turned out to be disastrous for those companies as well as their shareholders.
Researchers at the New York Fed refer to the BBB dynamic as a “subsidy” or an “exorbitant privilege” delivered in the form of abnormally lower debt service costs. No other class of credit-rated companies were so favoured. It was worth $300bn in total between 2009 and 2019. That figure shows the scale of the distortion to markets precipitated by unusual monetary policy in the wake of the financial crisis.
M&A investor presentations often include a bullet point on how — despite leverage taken on to fund a deal — the acquirer will quickly generate cost savings to pay off debt. The Fed researchers found that confidence was often misplaced. BBB acquirers regularly paid so much for targets that their credit metrics fell into junk territory. However, rating agencies remained lenient and resisted downgrading companies to this “fallen angel” status.
The Fed did not promote loose money over the 2010s to specifically boost blockbuster and ultimately ill-fated M&As. The takeaway from this study is that quantitative easing has been a decidedly blunt instrument — for which many dealmakers must however be grateful.
