Medill Reports Chicago
Multinational companies grab opportunities to borrow at bargain rates
March 31, 2015
By Lei Xuan
If you think the depreciation of foreign currencies against the dollar will harm U.S. multinational companies, stop worrying.
U.S. firms are grabbing at the opportunity to raise funds at an extremely low cost.
In the first three months of 2015, more than 20 central banks all over the world either cut interest rates or launched quantitative easing program to purchase sovereign bonds and asset-backed securities.
Either method would increase the supply of money in the financial markets. Usually, these methods will boost those countries’ economies, because the increasing supply of money will encourage spending as well as causing those countries’ currencies devalued, thus make their exports more competitive in foreign markets.
As the U.S. dollar has been advancing against most of the foreign currencies, U.S. multinational companies, from Staples office supplies to Coca Cola, reported that their earnings were dragged down when they convert foreign currencies to dollars.
However, U.S. firms found that they could actually take advantage of the situation too.
Borrowing in the U.S.
According to the Securities Industry and Financial Markets Association, the U.S. corporate bond issues reached $253.3 billion in the first two months of this year, a 13 percent increase over the same period of last year.
The trend is continuing in March. Many of the issuers went for big bucks. Pharmaceutical company Actavis PLC sold $21 billion in corporate bonds in the U.S. It was the second-biggest corporate bond offering in history.
Apple issued $6.5 billion in bonds in February. It was the fourth time in two years that the tech giant issued corporate bonds in the U.S. market as interest rates here remain near zero.
“If you are Apple, you’ll be foolish not to issue (bonds) now,” says Jody Lurie, vice president and corporate credit analyst of Janney Capital Markets.
Apple received an Aa1 rating from Moody’s, just below the U.S. Treasury Bonds’ triple A rating. Standard & Poor’s even gave Apple the same AA+ rating as U.S. Treasury Bonds. That gives Apple very high credibility and investors a very low risk of default.
Investors place a high demand on safer investment assets. Therefore, in bond markets, the higher the credibility a bond has, the less interest rate the issuer will pay to its investors.
“There’s already that demand, plus the rates are so low,” says Lurie. “They are getting (funds for) not free money, but near free money.”
The BofA Merrill Lynch US Corporate Master Index tracks the effective yields of investment-grade U.S. corporate bonds, which have BBB- or better ratings in the U.S. market. Lower yields mean lower bond interest rates or higher demand in the financial market. (Lei Xuan/Medill)
The BofA Merrill Lynch US Corporate Master Index tracks the effective yields of investment-grade U.S. corporate bonds, which have BBB- or better ratings in the U.S. market. Lower yields mean lower bond interest rates or higher demand in the financial market. (Lei Xuan/Medill)
Lurie says there have been a lot of companies coming to the market over the past few years. Has it not had low interest rates, it probably wouldn’t happen.
The short-term interest rates or the federal funds rate in the U.S. have been kept at near zero for more than six years in response to the 2008 financial crisis. It is widely believed that the U.S. central bank will start to “normalize” interest rate sooner or later this year.
“I think there are companies who are thinking that they’d rather come to market now over waiting, because if they wait, they will miss the opportunity,” says Lurie. “It is such a unique situation in the moment.”
Borrowing in Europe
Not only has the U.S. corporate bond market become hot. U.S. companies also participate actively in the European corporate bond market.
In the recent months, several U.S. companies issued euro-dominated corporate bonds in Europe. Wall Street Journal reported that U.S. firms have issued about $28 billion euro-denominated bonds since the beginning of the year, more than doubled over the same period of last year.
Coca Cola recently issued about 8.5 billion euro-denominated debts, equal to about $9.5 billion in U.S. dollars. The transaction was reported to be the largest euro-denominated bond transaction by a U.S. company, and the second largest euro corporate bond by any issuer.
Kellogg’s and the Oreo cookie maker Mondelez International are among other U.S. companies that taking the advantage of real low interest rates they have to pay.
“The interest rate that they pay on a euro-denominated bond from a maturity bond is much lower in Europe than what they would pay here in the U.S. So it’s a much cheaper financing source for them to issue in Europe than in the U.S.,” Morning Star Corporate Bond Strategist Dave Sekera says.
Every bond has its maturity, regardless whether it is dominated in the euro or in the dollar. Issuers pay a fixed interest rate to investors on a monthly basis. Corporate bonds usually have maturity from five to 30 years.
In addition, Sekera says corporations may benefit from the continuing advance of the dollar and the depreciation of the euro. If the trend continues in the following years, when those bonds mature, it will take those companies less dollars to repay those euro-denominated bonds.
Some experts believe another incentive for U.S. multinational firms is to avoid taxes. “They don’t want to repatriate their earnings [from] abroad to pay U.S. corporate tax,” says Mark MacQueen, co-founder and managing director of Sage Advisory. “So they issued U.S. debts at very low rates, using that money to run businesses. They can keep their cash abroad.”
U.S. firms don’t have to pay their abroad revenue taxes unless they bring that money back to the U.S.
According to accounting firm KPMG, the U.S. corporate income tax rate was at 40 percent in 2014, one of the highest in the world. The corporate income tax rate in the eurozone is about half of the U.S. rate, at 21.34 percent. For those U.S. companies that generate much of their revenues from foreign subsidiaries, locking money in the Europe would save them a lot of money.
Can the Fed slow down U.S. firms from borrowing?
While U.S. firms are taking the advantage of low interest rates across the Atlantic, the Federal Reserve, in a statement after the recent March meeting, dropped the assurance that “it will be patient” on deciding when to raise federal funds rate. The rhetorical phase is considered a clue that the Fed will raise the interest rate as early as June.
The federal funds rate influences the interest rates in bond markets because federal funds and bonds are competitive bank borrowing instruments in the market.
If the Federal Reserve raises the interest rates anytime soon, the cost of borrowing for U.S. corporate bond issuers will rise too. Does that mean the U.S. firms will not enjoy the low borrowing cost any more and the corporate bond market will cool down?
“Raising interest rates should slow issuance down, but the Federal Reserve is not going to raise the interest rates very much,” MacQueen says.
The central bank policy-makers lowered their expectations on the federal funds rate. Ten of 17 Federal Reserve board members and regional presidents projected the federal funds rate will below 0.625 percent at the end of 2015, a hint that the interest rates will increase slowly.
Accordingly, “corporate bond new issuance may slow gradually, but it is unlikely that new issuance would slow materially,” Sekera says.
Furthermore, the European Central Bank and the Bank of Japan are expected to continue their asset purchase programs for some time into the future. “We see competing interest rates are very low across all of Europe and across Asia,” says Sekera. “That will help keep our interest rates from rising too hard too fast in the United States.“
Even if the U.S. interest rates climb up at a faster-than-expected pace, U.S. multinational firms, who are usually the corporate bond issuers because they have the largest balance sheets, can still borrow cheaply in Europe.
“If interest rates in Europe remain mired near their historical lows,” says Sekera. “Then it would become more attractive for corporations to issue debt in Europe denominated in euros in order to reduce their overall interest expense.”
Photo at top: Coca Cola issued $9.5 billion worth of euro-denominated bonds in European market to borrow money at low interest rates. {Lei Xuan/Medill}
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