Mighty dollar keeps reverse Yankees rolling

IFR DCM Special Report 2015
9 min read

Bankers hate the name, but they will not be arguing with the underwriting fees. The boom in so-called reverse Yankees has been a dominant feature of the European debt markets since the end of last year, and in the early part of 2015, it accelerated as some of the biggest corporates and financial institutions from the US arrived on European shores to lock in financing at record low rates.

There was a record €90bn of euro-denominated debt issued by US corporates during the first nine months of 2015, propelled by jumbo deals from the likes of Coca-Cola, which took home €8.5bn in the biggest ever foreign offering by a US company, General Electric and McDonald’s.

The tally beat the previous high of €83bn that printed in the same period in 2014, according to Thomson Reuters.

Supply was front-loaded in a frenetic first half, during which yield-hungry European investors lapped up the extra spread on offer, as well as snapping up the chance to own prestige names in their portfolios. The boom created indigestion, and with the euro markets moving to a period of underperformance during the second half, the trade became less compelling. However, there remain sound reasons why the phenomenon is here to stay.

“The reverse Yankee trend is much more strategic than opportunistic. US companies are prepared to pay larger new issue premiums to get access to the euro market,” said Hugh Carter, head of credit syndicate at Commerzbank.

Before the reverse Yankee boom kicked in, there were already sound corporate finance reasons for US blue-chips to hit the euro market. Ever since market access froze in the wake of the financial crisis, treasurers have considered currency diversification as essential. At the same time, the euro market is appealing to US companies looking for unconventional tenors to fill out their credit curves.

Some US companies have been long-term issuers of euro debt for net investment hedging or funding acquisitions in Europe. Additionally, a limited number of prestigious US corporates such as telecoms giant AT&T have tapped the euro market for arbitrage purposes, with investors welcoming the quality of the name and the spread on offer.

“The likes of AT&T would come to the European market because they could issue in euros, add a healthy concession, then swap back into dollars at a more favourable rate than issuing in their own currency,” said one syndicate banker.

But this trickle turned into a torrent at the end of 2014, when anticipation of European Central Bank introducing quantitative easing just as the US Federal Reserve appeared to moving into a tightening cycle depressed euro bond yields and triggered a transatlantic scramble.

“Divergence in rates policies between the US and ECB prompted a huge visible change in thinking and, as a result, suddenly, international borrowers saw the attraction of issuing in euros. Companies started to become very focused on locking in low rates,” said Marco Baldini, head of European corporate and SSA syndicate at Barclays in London.

With European companies usually slow to come out of the blocks in January, US corporates quickly began to dominate the supply calendar as a procession of blue-chip names hit the market, propelling the first quarter to record highs. Coca-Cola was a stand-out issuer, printing the biggest non-dollar deal by a US company, but the pipeline featured issuers from across the spectrum, with US banks leading the charge.

The calendar took some bankers by surprise, and not just because of the sheer volume of issuance.

“Though we anticipated a pick-up in euro issuances by US issuers, the key drivers were different from what we expected,“ said Chris Abbot, executive director for investment-grade finance at JP Morgan, who moved to New York at the beginning of 2014 to work with the bank’s US clients looking to tap the euro market.

“We anticipated that the number one driver would be the frequent issuers looking for arbitrage funding and diversification. Instead, reverse Yankee issuance this year has been dominated by less frequent issuers looking to take advantage of the large interest rate differential and lower coupons available in euros, and to hedge their overseas assets in a rising US dollar environment.”

Treasurers at US companies have to take the cross-currency basis swap into consideration, especially when justifying their decision to print a deal that has a low coupon but a spread that is more expensive than in their home currency.

Not all about the basis

While the cross-currency basis swap is often cited as the measure that dictates an issuer’s decision whether to issue in euros or dollars, bankers say it was most favourable for US issuers eyeing the euro markets during the middle of 2014. So it does not fully explain the glut of reverse Yankee issuance, especially as it deteriorated during the course of the first quarter, after which it remained largely stable.

“The cross-currency basis swap gets a lot of attention but what’s been more important to valuations has been the relative performance of an issuer’s credit spreads in the different individual markets,” said Abbot.

For example, a sufficiently wide spread differential between the US and European credit markets can absorb an unfavourable basis swap.

Unlike the basis swap, which may prove a draw for more tactical issuers, the divergence in rates and the strength of the US dollar have been more important drivers and, say bankers, ones that are likely to remain in place over the longer term.

“If we continue to see a strengthening US dollar, that will prompt more overseas issuance from US borrowers as they look to hedge overseas earnings and foreign assets by issuing liabilities denominated in foreign currencies,“ said Abbot.

After a record-breaking first quarter, supply tailed off as indigestion crept in. While the European division of US fund managers were keen to add blue-chip US names to their portfolios, they soon started to buckle under the weight of supply .

“The massive volume of issuance meant European investors were closer to their portfolio limits for foreign holdings,” said Barclays’ Baldini.

Lack of familiarity breeds contempt

Also, investors started to push back as credits they were less familiar with started to jump on the bandwagon.

“The feedback we got from some investors was that they weren’t familiar enough with some names and didn’t want to have to hire extra analysts to cover new credits,” said one syndicate banker.

The reverse Yankee boom marks a further staging post in the growing liquidity and development of the euro debt markets, but it also tested its limits. Bankers say that as the dollar market underperformed, reverse Yankee credits suffered.

“If you look at AT&T, it was trading as a US name rather than as a telecoms credit alongside the likes of TeliaSonera,” said one banker.

Frequent funders proved nimble in exploiting arbitrage opportunities. During August, when the dollar market was worried about a huge supply calendar, the euro markets rallied and the result was a spurt of issuance from Canadian banks. Since then, the VW scandal has led to a period of underperformance in the euro market, prompting Yankee issuers to return to the dollar market.

“The basis swap works both ways,” said one syndicate banker.

While borrowers will continue to switch between markets depending on conditions, bankers believe that the fundamentals remain in place for the trend to continue. Even though the US Federal Reserve voted to keep rates on hold at their meeting in September, it remains a matter of when not if, the Fed starts to tighten.

Abbot said: “With the US looking to raise rates in the near term and rates in Europe not expected to go anywhere anytime soon, we believe a persistent interest rate differential will continue to attract US borrowers to the euro markets.”

Bankers say that differential has been in the range of 130bp–200bp during the course of the year.

What is clear from the wave of reverse Yankee issuance is that US companies are making corporate finance decisions based on the relative performance of individual credit markets. And as Europe’s debt markets continue to grow, they will prove an attractive destination, at least while the dollar reigns supreme and the ECB continues its bond-buying largesse.

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Nick Johnson, New York Yankees