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Capital Markets

Mulling Funding Options While Awaiting Tax Reform

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November 22, 2017

Wall Street looks to offer intermediate structure; CP offers cost effective alternative.

BenjaminsAs the tax reform ball moves into the US Senate’s court, prospects for a mandatory repatriation tax rate of 12% on overseas cash are growing brighter. However, reform is far from certain, and some companies may need the cash sooner than later, prompting them to mull how to best meet their funding needs. Meanwhile, Wall Street seeks to offer possible solutions.

The issue of intermediate financing arose at a recent NeuGroup meeting of the Assistant Treasurers’ Leadership Group (ATLG), when one member brought up his company’s deep-in-the-money convertible bonds. Conversion requests required several hundred million in USD, but the company’s onshore cash position was tight while dividends accumulated overseas from foreign subsidiaries were abundant. Today’s 35% repatriate tax rate makes bringing that cash home now unattractive, especially with the possibility of that rate dropping by almost two thirds just around the corner—Congress’s goal is to have a bill for President Trump to sign by Christmas.

In recent years technology, pharmaceutical and other US companies with significant cash holdings overseas have issued debt at historically low rates to satisfy their domestic funding needs. However, taking on more debt now with mandatory repatriation on the horizon, or possibly not, results in a separate set of concerns.

“We also needed to consider the possibility of tax reform not materializing, and if we take on debt does the interim financing become permanent, or do we term it out? And how does it affect the company from the standpoints of leverage and our rating?” the ATLG member said.

He added that some banks, including Wells Fargo and Deutsche Bank, have recently been marketing a 3-year bond with a one-year call option, enabling repayment of the bond soon after successful tax reform, as a potential solution. The bonds relatively short three-year maturity generated a nominal cost for the call option of about five basis points.

AvalonBay Communities decided to take advantage of the structure November 9, 2017. The REIT, specializing in residential properties and rated A3/A-, issued $300 million in 3-year, floating-rate bonds with a one-year call feature, for a coupon of three-month Libor plus 0.43%

Another interim financing option would be to arrange a bank term loan, but that could use up a company’s bank loan capacity and limit its ability to tap the bank market if need arises later. A company could also tap its existing revolving credit, which provides the ability to prepay quickly but typically a costlier alternative. In addition, the assistant treasurer noted, there appears to be a stigma attached to having drawn portions of a revolver remaining outstanding at quarter end and showing up on the balance sheet.

“The market thinks that maybe the company is in distress and doesn’t have access to other funding sources,” he said.

Ultimately, the company chose to upsize its revolver and use it as a backstop for a new commercial paper program, which was easily the most cost-effective funding alternative. The AT noted that the cost of the program was approximately 30 basis points over Libor, or about 1.5% all-in, compared to closer to 2.4% all-in for the 3-year bond, the next most cost-effective alternative.

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