As the European Central Bank embarked on quantitative easing in the first quarter, a number of U.S. companies, including Berkshire Hathaway, Coca-Cola and Kinder Morgan, took advantage of lower interest rates in Europe by issuing euro-denominated debt.
“The lower interest rates and lower borrowing costs in Europe are a benefit to companies,” said Sean Simko, managing director and head of global fixed income management at SEI.
According to research firm Dealogic, 25 U.S. companies sold euro-denominated bond issues totaling $30.9 billion in the first quarter. That’s up from the $10.1 billion worth of euro-denominated bonds sold by nine U.S. companies during the first quarter of 2014.
“In general, corporate treasurers will aim be active in different markets in order to diversify their investor base,” said Michael Larsson, director at Fitch Ratings in London.
In the current environment, Larsson said, with “record low spreads in European corporate bond markets,” as well as an improving U.S. economy, “you get a situation where they see the conditions are favorable to allow them to build on their investor base within Europe.”
The market for corporate bonds in Europe is generally perceived as less well developed than the U.S. corporate bond market.
But Larsson said that while European corporates relied heavily on bank loans prior to the 2008 financial crisis, since then, as banks deleveraged in response to new capital requirements, “there’s been a rising trend of disintermediation whereby corporates go directly to the bond market.”
As a result, he said, the size of the European corporate bond market is catching up to that of the U.S. market, with outstanding corporate bonds in Europe, the Middle East and Africa totaling about 2 trillion euros at the end of 2014, while the U.S. market totaled about 3.1 trillion euros.
During the first quarter, on average investment-grade euro-denominated corporate bond spreads were 60 basis points tighter than those in the U.S., while high-yield euro-denominated spreads were 160 basis points lower, Larsson said.
He suggested most U.S. companies are hedging the foreign exchange risk involved in issuing in euros.
While the cost of euro/dollar cross currency basis swaps has been rising, “if you look at the potential spread discounts, both investment-grade and high-yield, the spread discounts exceed the cost to swap it into dollars,” Larsson said. He noted though, that issuing in Europe isn’t cheaper all along the yield curve; for shorter maturities on investment-grade bonds, it can be cheaper for U.S. companies to issue at home.
Differing legal requirements
Of course, there are other considerations for U.S. companies issuing euro-denominated debt, such as the need to identify and court European investors and to deal with European legal requirements.
While most issuance is arranged out of London, companies have to consider the laws of the countries in which they plan to offer the debt, said Paul Clews, a partner in the London office of White & Case.
Investors like insurers, pension funds and mutual funds are located in various European cities, said Clews, pictured at left.
“When you’re marketing a bond in Europe, you want to approach as many of those pools of capital as possible,” he said. “In a typical European distribution, the corporate issuer may go to Paris, to Frankfurt, to London, maybe Amsterdam, maybe Madrid, maybe Edinburgh.”
“As a result, you need to comply with the securities offering laws in each of those jurisdictions,” Clews said, but added that “as a practical matter, bonds in Europe are usually placed with financial institutions and in a manner which is exempt from the European Prospectus Directive.”
“If you are distributing to institutional investors in a manner which is exempt from the Prospectus Directive, then you will comply with most, but not all, of the local restrictions on the offerings of securities,” Clews said.
Clearly, issuing debt in Europe means a U.S. company will need European legal representation.
For U.S. companies used to issuing in the U.S., “it is quite a different landscape in terms of what the requirements are and what you need to comply with,” said R. Jake Mincemoyer, a partner in the New York office of White & Case.
“It can be quite easy to comply with all the rules, but they aren’t rules a U.S. issuer would have come across before,” Clews added.
Outlook for euro-denominated issuance
The trend of U.S. companies borrowing in Europe seems likely to continue, especially since the cost advantage of issuing euro-denominated debt seems likely to grow as the Federal Reserve talks about raising rates while the European Central Bank continues to ease.
“As long as you see borrowing cost at these low levels, you will have U.S. companies continuing to tap that market,” Simko said. “On the other side, you’ll have Yankee issuers, [non-U.S. companies] who normally would tap our market, stay and issue in euros or other currencies.”
Simko said, though, that because the European corporate bond market is not as robust as the U.S. market, “I think there will be some type of limitation to issuance over there because of the depth of the market.”
Milton Ezrati, senior economist and market strategist at Lord Abbett, noted that European investors are seeing negative yields on some high-quality sovereign debt, like the bonds of Germany and the Netherlands. “The appetite in Europe is huge to get any kind of yields beyond what these sovereigns are offering,” Ezrati said, and predicted the European appetite for U.S. companies’ debt is likely to grow.
Larsson, pictured at left, argued that the euro-denominated issuance by U.S. companies “is creating momentum in the market, and investors will possibly be more accepting of further issuance.”
And in the high-yield market, U.S. issuers are helping rectify a shortage of supply.
“In terms of the European high-yield market, there’s definitely a lack of issuance versus demand,” Larsson said. “Investors now have to accept looser and looser terms, or lose out on primary supply, so they’re often not being paid for the risks they’re taking. Investors will welcome this U.S. influx.”
According to Dealogic, seven of the 25 U.S. companies that issued euro-denominated debt during the first quarter were high-yield credits. Among the U.S. high-yield issuers were Huntsman International, IMS Health and Infor.
Larsson suggested the trend of U.S. corporates issuing in Europe could be derailed if some sort of systemic contagion or geopolitical problem disrupted Europe’s cost advantage. He noted, though, that Greece’s current debt negotiations thus far haven’t had much impact on yields in Europe.
Ezrati said that at the same time that U.S. companies are issuing euro-denominated bonds in Europe, European investors looking for higher yields are buying dollar-denominated debt in the United States.
Such trends will help keep interest rates lower in the U.S., he said. While the Federal Reserve is expected to raise rates, “that is a pretty powerful countervailing effect,” he said.