The tax overhaul could change the corporate bond landscape, potentially bolstering existing bonds and credit-related ETFs as Corporate America reduces its reliance on debt issuance.
The proposed tax bill going through Congress would allow large multi-national companies to repatriate future foreign earnings more cheaply and diminish corporations’ need to borrow, the Wall Street Journal reported.
Multi-nationals would pay a one-time tax on their accumulated foreign earnings to repatriate the cash back onto U.S. soil, and there would be no extra tax on transferring that money across borders, which would provide many companies a quick alternative to the bond market the next time they want to employ money to invest or buyback shares. Consequently, the lower requirement to raise cash would diminish the corporate bond issuance between $80 billion and $160 billion one year after the tax law is passed, Daniel Sorid, a credit analyst for Citi Research, said.
Furthermore, the tax changes could make debt more expensive for companies by lowering the corporate tax rate and putting a cap on corporate interest deductions., which could stress some of the more highly leveraged companies. The current bills would reduce the corporate tax rate to 20% from 35% – President Donald trump has indicated he is open to a 22% rate, and this in turn would diminish the value of corporate interest deductions.
“All else being equal, if companies were able to deduct all of their interest expenses before and they will be limited in some form, that should make debt a less attractive option to them and they should be less inclined to issue bonds,” Oleg Melentyev, credit strategist at Bank of America Merrill Lynch, told the WSJ.
Consequently, if the supply of new debt dips, existing bond prices, along with related corporate bond ETFs, could see prices rises.
A tax overhaul “could have the largest impact on corporate finance in decades,” David Brown, head of global investment-grade credit at investment management firm Neuberger Berman, told the WSJ. “It could structurally change the way companies look to finance themselves.”
The U.S. corporate bond market is a behemoth in the global financial system, providing cash for a variety of ventures and projects. According to data provider Dealogic, nonfinancial, investment-grade companies in the U.S. have borrowed over $800 billion this year alone, which has already broken the full-year record of 2015.
Fixed-income ETF investors could also capitalize on the potential changes through investment-grade corporate bond-related ETFs, such as the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD), Vanguard Intermediate-Term Corporate Bond ETF (NYSEArca: VCIT) and SPDR Portfolio Intermediate Term Corporate Bond ETF (NYSEArca: SPIB).
For more information on the credit market, visit our corporate bonds category.