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Treasury & Taxation

US Corporates to Continue Eurobond Trend

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February 12, 2018

Key element fueling US corporate interest in Eurobond market is new limits on interest deduction

euro bank note coinsAfter three years of record issuance in Europe, US multinational corporations, especially leveraged firms, are likely to continue that trend in 2018, driven in part by US tax reform.

“The most important driver for US corporates issuing more in euros, reflected in our communication with clients, is the new US tax law’s limitation-of-interest deduction for C Corporations,” said Christoph Hampl, head of debt capital markets at Unicredit Americas.

Unicredit was ranked 2nd as book runner for Eurobond issues overall in 2017 and again so far this year, and 4th for corporate issues in 2017 and 3rd so far in 2018, according to Dealogic. Mr. Hampl said the Milan-headquartered bank does not see itself competing against the likes of JP Morgan and Goldman Sachs in the US dollar (USD) market, but rather focusing its strength on Europe and bringing US corporates to the Eurobond market.

The bank did a “deep dive” into the language of the new US tax law passed in late 2017, determining that a key element fueling US corporate interest in the Eurobond market is the interest-deduction limit. Starting this year, the provision limits the deduction of interest-expense to 30% of earnings before interest, taxes depreciation and amortization (Ebitda). In 2022, the limit is reduced to earnings before interest and taxes but after depreciation and amortization, a significantly smaller number. The provision mainly impacts leveraged companies with high interest expenses.

“In our communications with some issuers, it’s very clear that in the future they may want to raise more funds outside the US, to get the benefits of the law’s new territorial tax system,” Mr. Hampl said. “The largest source of liquidity outside the US market is the European market, so we expect there will be some impact on the European market in terms of issuance of reverse-Yankees,” referring to Eurobond issues by US MNCs.

Switching to a territorial tax system, another provision in the new law and a system that is used by most other countries, means companies will be taxed only on the income earned within a jurisdiction’s borders. So leveraged companies in the US who project their interest-expense exceeding the new law’s limits may opt to issue outside the US, in jurisdictions where they can still make use of interest-rate deductions.

Taking advantage of historically low rates, US corporates have issued record-levels of Eurobonds over the last three years, peaking at $72 billion last year, following $70 billion in 2016 and $68 billion in 2015. Mr. Hampl noted that the number of deals, however, declined in 2017 compared to the year before, to 98 from 110 in 2016 and 105 in 2015.

“It’s not a big difference, but it shows a trend. Some larger, acquisition-driven transactions, such as AT&T’s issuance, made up a significant part of last year’s volume,” Mr. Hampl said. He added that overall US companies were the largest group of Eurobond issuers, followed by German, French, and Italian issuers. GE Capital issued the largest reverse Yankee deal at $8 billion, followed by AT&T at $7 billion, Pfizer at $4 billion, and Verizon at $3.5 billion.

Most offerings were by established US issuers in the Eurobond market, Mr. Hampl said, although they hadn’t tapped it in a few years. Some issuers such as Netflix Inc. and McKesson Corp. were new to the market. Mr. Hampl said the reverse Yankee market (bonds issued in the US by a foreign government or company) in 2017 was dominated by fixed-rate issuance, with 81% of that coming from investment-grade companies. Non-investment trade companies made up 50% of reverse Yankee issuance in 2017, compared to only 10% the year before.

Reverse Yankee issuers were driven in part by the need to fund their European operations without incurring currency-swap risk. In addition, Mr. Hampl said, noninvestment-grade issuers were able to extend maturities out to 10 years for the first time ever, and investment-grade issuers found a more receptive market for 20-year maturities. Perhaps the biggest reason was simply overall costs, as the European Central Bank (ECB)’s quantitative easing program has kept rates near record lows.

“If a company keeps a Eurobond issue in fixed-rate form on its balance sheet, and doesn’t swap it, then it’s more than 2.5% cheaper issuing in Euros than USD,” Mr. Hampl said. He added that there is some concern about rates rising in 2018, especially in the second half of the year, although there are indications an increase may come sooner. Concerns about rising rates may prompt some inaugural US issuers to tap the market sooner rather than later, and Mr. Hampl said that’s where Unicredit anticipates much of the reverse Yankee volume coming from this year, rather than seasoned issuers.

While the market may be concerned about rising rates, Mr. Hampl said, issuers are not concerned about liquidity. “This is important,” he said, “because the Eurobond market has become such a good alternative to the USD market that if the USD market is not available for a certain period, issuers could easily fulfill their funding requirements their funding requirements in Europe.”

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