Why Netflix’s Bond Offering Is Good News For The Markets And Economy

Netflix’s (NFLX) bond offering is appointment viewing for the markets and CFOs. After reporting a stellar quarterly performance last week, the company announced plans to raise $2 billion via corporate bonds, split equally between U.S. dollar debt and euro bond. Many other publicly-traded companies, such as MGM Resorts (MGM) and Ford Motor Company (F), have also rushed to raise capital through bond offerings in the post-COVID world. 

These offerings are messengers of good news in these difficult times, both for the companies raising them and, more importantly, for the economy as a whole. In particular, this is a promising sign for the transmission of unconventional monetary policy that the Federal Reserve Bank undertook just a month ago. It also tells us that the market as a whole is getting comfortable with the credit risk of large corporations. All of this bodes well for economic recovery, at least from the financial side. 

Central banks use interest rates (e.g., the Federal Funds Rate in the U.S.) as their primary tool for changing money supply in the economy during regular times. Often this is implemented by buying or selling short-maturity Treasury securities in open markets. When the Fed buys these government-issued securities from a bank, it gives them cash (cash-like deposits at the Fed to be precise) in return, leading to an expansionary monetary policy. The reverse happens when it sells securities to them. This is the conventional monetary lever that the Fed pushes and pulls in less eventual times. 

The usual policy response is not enough as COVID-19 ravages the economy.  When lowering the Fed funds rate is unlikely to meet the credit and liquidity needs of corporations and households, central bankers look for unorthodox  monetary policy tools—for example, directly purchasing securities issued by non-government entities. This approach stands in sharp contrast to the more common  approach in which the Fed only transacts in Treasury securities, and leaves the next step of providing credit to the main street entirely to the banking sector.

Indeed, when The Fed intervened in March 2020, it did so with a host of unconventional monetary policy tools. Three programs specifically targeted large corporations: Commercial Paper Funding Facility (CPFF), Primary Market Corporate Credit Facility (PMCCF), and the Secondary Market Corporate Credit Facility (SMCCF). In addition to directly providing credit to companies, these programs have a significant indirect effect via improved liquidity in the corporate bond market as a result of the Fed’s bond purchases. Improved liquidity, in turn, allows companies to raise more debt in the capital markets on their own.

When the Fed intervened in March, it was far from clear that these policy initiatives would be successful. The availability of credit is only a necessary condition for the uptake of credit. If risk-aversion skyrockets, borrowers would not take credit, no matter how much credit is available for them. Similarly, if the financial sector is distressed, it may not be willing to transmit the benefits of expansionary monetary policy from the Fed to the real economy due to its own unwillingness to lend. In extreme cases, there is always a concern about the “liquidity trap.” If markets see the Fed’s action as a sign of bad things to come, higher liquidity from the Fed may end up incentivizing everyone to hoard more cash rather than lend.

Netflix’s bond offering, against this backdrop, is an excellent piece of news for the markets. It gives hope that the Fed’s policy interventions are working, and companies across the spectrum of credit ratings can access capital markets. Moody’s currently rates Netflix as Ba3, which is below the investment-grade cutoff. When companies below the investment-grade rating are able to raise debt in the market, it is clear that the market’s risk-appetite is back.

In its initial announcement, the Fed had decided to provide access to its newly announced facilities only to investment-grade firms. Later, it amended the terms to allow “fallen angels,” i.e., companies that were rated investment-grade before the COVID-19 crisis but are now junk-rated, to access these funds as well. In Europe, the ECB followed suit and recently decided to accept “fallen angels” as collateral from the European banks for accessing the ECB’s liquidity facilities. These policy initiatives make it easier for fallen angels as well as other lower-rated firms to raise capital through bonds or syndicated lending facilities. Indeed, the last few weeks have seen record amounts of bond issuance by such companies. Netflix’s bond offering should give comfort to the policymakers that their support is reaching lower-rated firms as well.

Second, financial markets are forward-looking. The bond market carries valuable information about the market’s perception of default risk in times to come. In a crisis, the risk of default becomes high, and sometimes the debt market completely shuts down. Of course, Netflix is a winner of the lockdown economy, and it may be tempting to conclude that its bond issuance is good news just for firms that benefit from the lockdown. But several other companies from a variety of industries and across the credit rating spectrum have also issued bonds in the past few months. Even companies like Macy’s (M) are exploring the option of raising debt backed by their real estate assets. It seems that the market as a whole is optimistic about the future of credit conditions. 

CFOs are looking at every possible avenue to raise cash in the post-COVID world. Netflix’s experience suggests that the debt market is open for business. And, interest rates are at an all-time low. Under such conditions, the supply of credit is not a major concern. Therefore, the decision to tap the bond market depends primarily on company-specific factors, i.e., based on the classic trade-off involved in raising debt versus equity. Companies with lower default risk, stable core business, and more tangible assets should consider raising debt at a time like this. While Netflix plans to use its bond offerings for aggressive investments and acquisitions, even for firms that do not have an immediate need for investments, raising debt to keep cash may not be a bad strategy in these times.

The critical issue CFOs need to think about is their company’s default risk, i.e., they should not take so much debt that the threat of bankruptcy becomes a real possibility. If that were to happen, debt burden can become a drag on their recovery from the crisis. Therefore CFOs must carefully evaluate the trade-off between liquidity and solvency: raising cash with debt improves the liquidity of the firm, but it also increases its risk of insolvency. Further, firms with higher tax burden should consider raising debt to avail of the interest tax shield of debt. Hence, the decision to raise debt depends on the relative costs and benefits of all these forces. But one thing is clear: this is an ideal time for CFOs to take a closer look at their capital structure.

To be sure, we need medical and public policy solutions to overcome the COVID-19 crisis. But the credit market seems ready to play an active supporting role in this recovery.