New Trump law to upset debt investors

Credit risk could increase for US companies if changes to corporate tax laws encourage them to use repatriated foreign earnings to buy back shares rather than to repay debt, according to Standard & Poor's. 

But funneling billions of dollars into jacking up shareholder returns could affect corporate credit ratings, the ratings agency argued. 

President Trump has mentioned a one-time repatriation tax of ten per cent, while Congress has proposed a tax of 8.75 per cent on cash and 3.5 per cent on non-cash assets. 

Repatriation under a ten per cent rate could result in US$1 trillion of cash inflows for rated companies, according to S&P. US non-financial companies rated by S&P held roughly US$1.84 trillion in cash and investments at the end of 2015, with US$1.1 trillion, or roughly 60 per cent, offshore. 

“Most, if not all, large US multinational firms would take advantage of the opportunity to repatriate billions of dollars of overseas cash," said S&P analyst, Andrew Chang. “And credit risk could increase if companies become more aggressive in their shareholder returns than currently expected.

“Would they balance the needs of shareholders and debtholders by purchasing shares and repaying debt, or would they succumb to the pressure from activist investors and use most of the proceeds for shareholder-friendly activity, as happened during the 2004 tax holiday?"

Share buybacks up

Chan is expecting the number of share buybacks and special dividends to increase substantially, as in 2004 when most of the US$350 billion in repatriated earnings was returned to shareholders.

All in all, he is predicting to see a decline in net cash balances as excess liquidity is returned to shareholders, and with it, rising leverage for some and a reduced cushion for others.

“Specifically, the top one per cent of our issuers alone could repatriate more than US$700 billion over time and return a significant amount of this cash to shareholders - although some would almost certainly go to pay down debt or meet upcoming debt maturities," he calculated.

While there are few expected downgrades for the top 25 largest rated cash holders - which control more than half of overseas cash - those rated BBB and lower could see their debt downgraded if they use repatriated cash to buy back stock. 

US non-bank corporate bond issuance has grown by about 23 per cent over the past four years, averaging more than US$600 billion per year, but issuance by the top one per cent more than tripled to an estimated US$150 billion in 2016 from less than US$50 billion in 2012. 

“Much of this debt issuance has come from companies that have significant cash on their balance sheets, most of it overseas, in a process that we term synthetic cash repatriation," Chan said.

“Investors purchased this debt, in part relying on the trapped overseas cash as a cushion supporting the debt. The cash existed but was unlikely to be used, and the semi-permanency of the overseas cash created demand for such debt. 

"The thought of this safety net disappearing through shareholder returns, leaving only debt on borrowers' balance sheets, naturally may concern debt investors."

Capital Markets,
bonds, credit risk, S&P
Elizabeth Fry,
Article Posted:
February 15, 2017

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