Why is CVS Issuing Bonds?

The drugstore chain CVS is issuing bonds to help fund its planned purchase of health care provider Aetna.

In December, CVS announced a $69 billion merger deal that would combine the operations of the two companies. The deal has yet to be approved by regulators.

Nevertheless, the merger will require a lot of money, and in order to fund the acquisition, CVS will need to raise some cash.

This week, CVS said it will do that that by selling $44 billion in corporate bonds. It’s reportedly the largest corporate bond sale in two years, according to the Wall Street Journal.

What are bonds?

Bonds are one of the most important parts of how financial markets work. And the bond market is large and complex, nearly twice the size of the global equities market, worth about $92 trillion, according to recent industry research.

As interest rates increase, bond prices tend to fall.

Both governments and companies sell bonds when they want to raise money. Think of bonds like a loan you make a company, which then promises to repay what it has borrowed within a set period of time, while making interest payments.

When the U.S. government issues bonds, they’re called Treasuries, and these bonds typically mature in ten to 30 years. (The government also issues bonds with shorter maturities, called T-bills.) Maturity means the period after which the bond’s original amount must be paid back, including any interest payments.

What are corporate bonds?

When companies issue bonds, they’re called corporate debt. Companies of all kinds issue bonds, and they do it to fund their operations, to conduct research and development, or to make acquisitions, among other things.

Companies typically pay more interest than the U.S. government for their debt, for several different reasons. One is that the interest on corporate debt is taxed–so to make up for that, businesses have to increase the yield on their bonds.

Another reason is that corporate debt is also inherently more risky than government debt.

Think of it this way: a company doesn’t have the power or resources of the U.S. government to promise repayment. A greater variety of things can happen to companies, even the largest and most stable companies. They can have bad years, or even go out of business.

So investors–most of whom buy bonds through mutual funds and ETFs–expect a higher interest payment for the debt, to compensate for the extra risk.

Corporate bonds are rated

There are two kinds of corporate debt: investment grade, and something called “junk”, based on industry ratings.

There are three ratings companies that research bond debt and produce a grade for it. They are Standard & Poor’s, Fitch, and Moody’s. Each one has a slightly different way of rating bonds, but the top grade for investors for all three is what’s known as a triple A, or AAA, rating. Investment grade bonds are anything above a triple B, or BBB, rating.

Junk bonds

Some companies issue bonds that are not considered investment grade. Their bonds are referred to as junk bonds.

In order to get investors to pay for the bonds, companies often offer drastically higher interest rates, or yields. That makes the bonds more attractive to investors, but the investments can potentially have a higher rate of default, which means they may not pay back the loan.

As interest rates increase, bond prices tend to fall.

These bonds have low credit ratings, or no ratings at all, because the companies issuing them may be experiencing serious financial troubles.

Inflation, interest rates and the bond market

The bond market has been going through a transition lately. Interest rates are rising and there are fears about inflation. As interest rates increase, bond prices tend to fall.

Low interest rates are good for companies that issue debt. Think of it like your credit card. The higher the interest rate, the more expensive it is to carry debt. So it is with companies. If they can issue debt that investors buy at lower rates, it’s more affordable for them to pay it back.

In 2017, with global interest rates hovering below 2%, companies issued record numbers of new investment grade bonds, with global bond volumes reaching $3.3 trillion, according to reports.

But interest rates have ticked up half a percent in 2018, which has made it more expensive for companies to issue bonds.

CVS, which will issue up to nine sets of bonds with maturities ranging from two to 30 years, and could offer interest rates of 4% or more.