Saturday, 22 September 2018

Credit markets buoyed by US tax revamp, but still many unknowns

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A long-awaited tax reform proposal announced by the Republicans on Wednesday gave credit markets a boost, but corporates are unlikely to change their financing plans until there is more clarity on the details.

A pledge from the Republicans to cut the corporate tax rate to 20% from 35% helped drive bond spreads tighter across the board on expectations that this would boost corporate earnings.

Bank bond spreads, for example, were trading up to 4bp tighter in secondary, according to MarketAxess.

But other proposals - including a one-time tax cut on the repatriation of overseas cash and a limit on how much companies can deduct debt interest expenses from tax - were still vague and fell short of what some in the market had been hoping for.

“While we have some information, they are other data points that are missing,” one credit strategist told IFR.

“But one thing we can comfortably say is that lowering the overall corporate tax rate will be a benefit to corporate earnings.”



Among the unknowns still is how much companies will be charged if they bring back cash from overseas - and a factor that could influence the financing plans of companies such as Apple that has billions of cash held outside the US.

Some bankers have suggested companies like Apple might have less need to sell corporate bonds to finance shareholder return programs if they bring back this cash at a lower tax rate - and thus slow a record run of corporate bond issuance. nL1N1FM26B

It is also unclear by how much policy makers would like to reduce interest deductibility. Lowering the so-called “tax shield” could have a more adverse impact on highly leveraged companies.

“Of concern is the proposed limit to interest deductibility – a century-old provision that helps companies grow over the long term,” said a statement from the American Investment Council.

“Interest deductibility is an essential component of businesses which rely on debt financing – companies of all sizes and across all sectors.”

Another proposal, however, - to allow for the full expensing of capital expenditure in the first year - is expected to encourage companies to boost spending on plants and equipment.

But that also has specific restrictions. It cannot, for example, be applied to spending on physical buildings.

It could be a benefit for some companies though, and help mitigate negatives elsewhere.

“The cut in allowance of interest expense may be offset with the ability to expense capital investments immediately,” Putri Pascualy, managing director and partner at PAAMCO, told IFR.

“Given prior mention of real estate investments as an example of capital investments one can expense immediately, there will be winners and losers among different sectors.”

Pascualy also noted, “The most dramatic interpretation of the text is that the interest deductibility of a lot of bond issuers will be cut. In this case, long term issuance of bonds will drop.”

And it “will put a crimp on leveraged buyouts and/or dividend recap, two things from (the) private equity playbook,” she said.

The proposal now faces a long legislative process that could take months. Trump has appealed to Democrats to support the plan, although they were not consulted in drafting it.

“The idea that a tax bill looking remotely like this may pass in Congress is fantasy. There is something for everyone to hate in this,” Richard Farley, a partner and chair of the leveraged finance group at Kramer Levin, told IFR.


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