US corporates are issuing more investment-grade debt than ever. But will new tax inversion laws crimp issuance?
By any measure, it has been a great few years for US debt bankers. More investment-grade paper (US$96.8bn) was issued by US corporates in May 2016 than during any single month in history, breaking a record that was itself just three months old. According to Thomson Reuters data, seven of the 10 biggest months for US corporate debt sales have occurred since the start of 2015.
Issuance of investment-grade corporate bonds hit US$1.52trn in the full year 2015, beating a record set the previous year (US$1.16trn). It is hard to argue with the notion that the debt markets in general – and issuance figures are also generally blindingly good across Europe and Asia – are enjoying something of a golden era.
And remember – this is taking place against the backdrop of a market boasting both a slew of strong fundamentals (solid growth figures in the US and UK; the ECB’s recently announced and unprecedented plan to buy investment-grade corporate debt), as well as some genuine points of uncertainty (notably, the question mark hanging over the UK’s European referendum).
Despite the occasional doubts and distractions, and overlooking a few genuinely wobbly moments (it is easy now to forget that sales of senior debt were, through the first six weeks of 2016, at their lowest levels in 13 years), the “overall tone of the [debt capital] markets has been excellent” this year, said Richard Wolff, head of US bonds, project bonds and private placements at Societe Generale.
“Investors aren’t happy with the volatility on the equity side of things but they are very happy with the stability of the corporate bond market. With most investment-grade deals well oversubscribed, it remains a very good environment for issuers looking to access the market.”
And absent a sudden change of mood on the part of the US Federal Reserve regarding its interest rate policy, it is hard to see that changing much, the usual upcoming summer lull notwithstanding.
Said Andrew Menzies, head of DCM origination for the Americas at SG: “ The US fixed income investor base is able to absorb substantial deals done in a way that it simply could not have done in years gone by. Year-to-date, US$4bn-plus deals make up more than 50% of the total supply of US corporate investment-grade bonds. Large deal sizes are becoming ever more prevalent.”
The other major factor underpinning debt sales is, of course, the timely and ongoing revival of the mergers and acquisitions market, a corner of the capital markets industry that remains as momentum-driven as ever.
Since the millennium, there have broadly been three major surges in M&A dealflow: a brief one at the height of the dotcom boom, followed post-2005 by a longer one pinched off by the global financial crisis. That trio is completed by the market’s more recent return to form, which has included a seemingly never ending flow of impressively eye-popping deals. At least 70 US$10bn-plus M&A deals were completed globally in 2015, according to Thomson Reuters data, led by AB InBev’s £69bn (then US$104bn) October 2015 bid for SABMiller.
Outsized US-led or US-related transactions this year so far include Johnson Controls’ US$36bn merger with Tyco and Shire’s US$32bn tie-up with Baxalta.
And there is still seemingly plenty of gas left in the tank.
“We are clearly in an M&A mega-cycle,” said Travis Barnes, co-head of global DCM & RSG at Barclays. “When you have some of the larger players in an industry combining, it could lead to more consolidation. There is US$120bn in supply remaining in the announced M&A calendar, and that number could return to previous levels” – which until recently was closer to US$200bn. “That’s how it’s been for the past 18 months. As we complete event financings, more M&A has been announced.”
All of which constitutes yet more great news for debt bankers. There is little doubting the correlation between a lively M&A industry and investor appetite for high-grade paper. Four of the 10 biggest ever months for sales of investment-grade US corporate debt (September 2013 and March, May and July 2015) were also among the top 10 months for US-related M&A dealflow.
“Record investment-grade debt issuance is being driven by M&A deals, which accounted for US$53bn of supply in [May 2016] alone,” said Barclays’ Barnes. “The jumbo M&A transactions have been multiple times oversubscribed – and they are some of the best performing deals.”
Another New York debt banker said: “The entire outperformance of investment-grade credit is attributable to the primary market – in other words, new or newish transactions. M&A deals are warmly welcomed by investors, who get great access to the issuers and the deal teams. Those deals tend to perform well, as the Street has a tendency to channel liquidity around those transactions.”
In short, so long as corporates continue to borrow in order to merge with or gobble up one another, the better the financial year for debt bankers.
The only real cloud on the horizon is the threat presented by the current White House’s clear distaste for so-called tax inversion deals.
When the US Treasury said in April it would ‘rein in inversions’ – deals that involve a US firm buying a foreign corporate, then changing its tax residence in order to cut the amount of corporate tax it pays – it had several immediate effects. Notably, it all but nixed the chances of Pfizer completing a planned US$160bn takeover of Ireland-domiciled Allergan. Both firms immediately scrapped the deal ‘by mutual agreement’.
This was not the first inversion deal scuppered by US regulators: in 2014, AbbVie had to drop its plans to buy the UK’s Shire for US$54bn. But the introduction of the new rules did signal that the occupants of the Treasury Building were serious about preventing real and pseudo foreign firms from bulking up by acquiring US firms, then moving their tax domicile. That, regulators said, was Pfizer’s aim. Once the Allergan deal had been finalised, likely in the second half of the year, the plan was to switch its tax address to Dublin from New York.
Many are split over the new rules. Allergan only pays Irish levels of corporate tax because it was itself bought by another US firm, Actavis, which moved to Dublin after being bought by Ireland-based Warner Chilcott. To some, that is the very definition of, to borrow the Treasury’s own term, a ‘serial inverter’. To others, it is a case of federal over-reach.
Jill Harding, managing director of San Francisco based Alvarez & Marsal Taxand, a global independent grouping of tax advisers, said: “A lot of these [inversion-style] transactions were happening not just for tax benefits but for legitimate business reasons, most notably that they benefited both of the firms involved, buyer and bought.”
Harding said the Treasury’s new rules constituted a “top-down policy”, and added: “Federal rules governing inversions have not been changed by Congress and will not change until 2017 at the earliest.”
So, whether a ban on inversion deals remains in force or is scrapped within months or years depends largely on the views of both the next occupant of the White House and of the 115th US Congress.
For now, the new rules will give pause for thought to any corporate or investor looking to buy a US entity and then switch its tax base. The rules include a three-year ‘look-back’ trigger, which will make it harder for smaller foreign firms to absorb larger US-based companies. And they make it harder to buy a US firm using too much leverage. M&A deals, said Taxand’s Harding, will “continue to change in favour of having a greater cash component”.
But what of sentiment – will the lively M&A market and the boisterous US investment-grade debt sector be much affected by the new rules?
At the moment, it is hard to say. Harding said the rules have the capacity to “massively affect the industry”, tamping down deal flow in the near to medium term. One senior New York banker said inversion deals “driven by tax or motives around the domicile of the buyer will impede certain forms of M&A”.
Others are not so sure. So far, the new inversion rules have shown little if any sign of crimping dealflow.
“I haven’t seen many recent situations where we see clients worrying whether a deal will be approved or not,” said one New York-based banker. “The [Obama] administration has done everything possible to be problematic, yet M&A dealflow, as everyone can see, remains relatively robust.”
Nor are new rules likely to dent the eagerness of US firms to issue investment-grade debt. Corporates continue to issue high-quality paper at a record pace, using the proceeds to fuel organic and inorganic expansion.
“The availability of extraordinarily cheap capital will likely continue to drive strategic activity across the corporate world,” said Jonathan Fine, head of US investment-grade debt capital markets syndicate at Goldman Sachs.
“So far, the attempts to stop inversions have not impacted the flow of supply,” said Societe Generale’s Menzies.
Another banker said investment-grade debt would “remain a great place to hang your hat. It will continue to function at a very high level, irrespective of what happens in the M&A world, as it is primarily driven by technical factors”.