Boeing and Bond Traders Brace for Junk

(Bloomberg Opinion) -- Both Boeing Co. and bond traders appear to be bracing for a downgrade of the aerospace giant to a junk credit rating.

The planemaker is launching a jumbo bond deal that could ultimately raise as much as $20 billion for the company, depending on demand, a person with knowledge of the matter told Bloomberg News. Just a day earlier, Boeing had pledged to explore “all of the available options” to secure sufficient liquidity to weather an unprecedented slump in travel demand that CEO Dave Calhoun has warned could last for three years. S&P Global Ratings lowered its rating on the company’s debt on Wednesday to BBB-, the lowest tier of investment grade, citing expectations for weaker cash flow and earnings over the next few years as Boeing grapples with not only the coronavirus but also the ongoing grounding of its 737 Max jet and production issues with its KC-46 military tanker. The bond deal is being marketed in seven parts, with portions due in three, five, seven, 10, 20, 30 and 40 years. Initial price talk suggests Boeing will have to offer yields more than 500 basis points above Treasuries across maturities. Those are much wider spreads than current secondary-market trading would indicate and are more in line with levels last seen during the depths of the market swoon a month ago.

A Bloomberg Barclays index of double-B rated corporate bonds, with an average maturity of about seven years, has a spread of 535 basis points more than Treasuries. Triple-B securities on average yield 266 basis points more than their benchmark. It suggests bankers are going with the tried-and-true strategy of luring in investors with elevated premiums and then tightening pricing before the deal closes. Indeed, in less than four hours, Boeing reportedly received $50 billion of orders for the offering.

Arguably the most interesting part of this particular offering is that it comes with a so-called coupon step-up provision. What this means is that under the terms of the deal, Boeing would increase interest payments by 25 basis points each time S&P or Moody’s Investors Service lowered its credit rating by one level into speculative grade. For example, if both S&P and Moody’s downgraded Boeing to their highest speculative grades, BB+ and Ba1, respectively, the coupon would increase by 50 basis points. If S&P alone cut the company by two steps from its current BBB- level, to BB, that also would be worth a 50-basis-point hike in interest. It’s capped at 100 basis points per credit-rating company and 200 basis points in total.

This structure has become something of a trend lately for companies teetering on the edge of junk, particularly those in travel-related businesses that have been hard hit by coronavirus lockdowns and a shuttering of global borders. Expedia Group Inc., Marriott International Inc. and Hyatt Hotels Corp. are among those that have used it. Both sides benefit from such an arrangement: Bond buyers get added downside protection to help offset the typical price declines when a company becomes a “fallen angel,” while the firms are likely able to raise more cash than they otherwise could and have yet another reason to defend their investment grades. But another way to read it is that there is a legitimate concern among bond investors about whether the lasting fallout from the coronavirus pandemic may jeopardize these investment-grade credit ratings, and an acknowledgement by the companies of that reality.

Asked on Boeing’s earnings call Wednesday how important it was for the company to remain investment-grade, Chief Financial Officer Greg Smith offered less of a hard commitment and more of a preference and acceptance of the fact that the ultimate fate of its rating was somewhat out of its hands. “Certainly, we would like to maintain being investment grade, and I think as you’ve heard and seen, we’re doing everything possible to do that. But look, the market is probably going to impact that more than anything,” Smith said. “At the end of the day, it's going to be what it’s going to be.”While Boeing is eligible to participate in a $17 billion bucket of government stimulus money dedicated to companies involved in work critical to national security and says it’s still reviewing its options on that front, Calhoun has balked at the Treasury Department’s demands for an equity stake and has indicated the mere existence of the $2 trillion CARES package and a Federal Reserve bond-buying program is helping open up the credit markets to companies like his. Boeing ended the first quarter with $15.5 billion in cash and marketable securities after drawing down the full amount of a $13.8 billion term loan, but CFO Smith acknowledged Boeing’s daily cash burn since the end of March was eating into that cushion.

Boeing churned through $4.7 billion of cash in the first quarter and said free cash flow will be negative for the year. It does expect that metric to swing to the positive in 2021, although the degree of improvement will be limited by plans to significantly curtail production, particularly on the grounded 737 Max. S&P in its downgrade said it now expects Boeing to generate as much as $10 billion of positive free cash flow next year, after burning through as much as $20 billion in 2020. It had previously expected as much as $14 billion in free cash flow in 2021. A Bloomberg measure of default risk, which incorporates share price and volatility, debt levels, interest expense and trailing 12-month cash flow, deems the company deep into high-yield territory, well below its actual credit ratings from S&P and Moody’s

The history of coupon step-up provisions during the last recession paints a mixed picture. According to data compiled by Bloomberg, these were the three biggest bond sales from December 2007 to June 2009 that had such clauses:

Dow Chemical Co. sold $6 billion of debt in May 2009. The notes were rated Baa3 and BBB-. The company never fell to junk. Altria Group Inc. sold $6 billion of notes in November 2008, in what was then the company's biggest ever deal and the largest in the U.S. market since well before the onset of the financial crisis. The debt was rated Baa1 and BBB+. The company never fell to junk. International Paper Co. sold $3 billion of notes in May 2008, in what was its largest debt offering in eight years. The securities were rated Baa3 and BBB. The company never fell to junk.

Of course, there were companies that didn’t fare as well. Notably, Residential Capital LLC, the mortgage lending unit of GMAC LLC, sold $1.25 billion of notes maturing in five years in May 2007 with a coupon step-up for downgrades. Not surprisingly, ResCap defaulted on its debt. For investors, the question is whether aerospace companies are this crisis’s equivalent to mortgage lenders, destined to be permanently wounded by the coronavirus impact on travel demand, or if Boeing is still a blue-chip company that can weather any storm.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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