Synthetic repatriation continues with an eye to tax reform within a five-year horizon.
At the spring meeting one of the key takeaways was that debt capital markets at the time remained very receptive to tech issuers, even as tapering was well underway. This is important since shareholder activism continues to be a concern, with no signs of dissipating, so Tech20 members remain focused on not only returning cash to shareholders but on becoming increasingly transparent in communicating plans to do so going forward. Thus, debt issuance is largely a form of synthetic repatriation with proceeds used to return cash to shareholders without the tax consequences. The hope is that this form of repatriation will placate activists sufficiently to avoid a tax haircut on offshore cash until such time as US tax reform is implemented. There was something of a consensus that tax reform was five years away, triggered either by a new Administration in 2017 or some sort of major market event (given that the last tax holiday came on heels of 9/11). Further highlights from the meeting, sponsored by Bank of America Merrill Lynch, included:
1) Positive capital market for tech. Bank of America Merrill Lynch offered a positive outlook on investor appetite for Tech debt. This view was endorsed by several members with recent experience in debt markets. The hope is for investor receptiveness to continue as the Fed moves to raise rates.
2) Manageable reg impacts on bank relations. Bank of America Merrill Lynch assured members that most, as strategic clients, would feel limited direct effects from bank regulatory impacts. Though they should be aware of the regulatory challenges and seek to mitigate the risk of impact by mixing up their bank groups.
3) Teaching financial smarts across the company. One way for a company to be successful is to get all employees onboard when it comes to the financials of the company, i.e., where they fit in the big picture and how it impacts the P&L and the balance sheet. Two member companies presented their unique approaches to educating employees on financial management topics.
4) Investment management amid the taper. Members indicated they were already shortening their cash investment portfolios in order to reduce exposure to rising rates.
Sponsored by:
Debt Capital Markets and Capital Return Strategies and Trends
Market continue to challenge companies and in particular their treasuries. The economy has remained in a low-interest rate environment with slow growth. But that may change in the coming months with the end of the Fed’s tapering program. Bank of America Merrill Lynch set out a few possible scenarios, including how the appetite for corporate debt continues strong and how going this route still beats repatriating cash from overseas.
KEY TAKEAWAYS
1) Strong liquidity trend continues for both dollar and non-dollar debt issues. There is enough liquidity and demand in debt capital markets to support another Verizon-size transaction. Also, the trend to diversify into other funding currencies and take advantage of arbitrage and low-rate opportunities continues.
2) Total debt in Tech is growing in lock-step with shareholder distributions. The low-yield environment combined with appetite for debt has seen Tech debt growth highly correlated to growth in shareholder distributions. Of course, turning to debt is cheaper than repatriating cash “trapped” offshore for tax reasons.
3) More desire should be seen to add floating rate debt. The reason to add floating-rate exposure can be either for ALM reasons to offset shorter-duration investments or to take a position on interest rates. Rising cost in swaps, due in part to regulation, have made issues of floating rate notes and CP more attractive as a means to create floating rate exposure. Bank of America Merrill Lynch analysis suggested that the majority of Tech20 firms (with cash to debt ratios of at least 1:1) should only be between 0-12 percent fixed in order to minimize interest cost volatility. The pre-meeting survey results showed most members more fixed.
OUTLOOK
An active way treasurers can keep synthetic repatriation going (other than to lobby Moody’s) is to conduct the capital management and planning mentioned in the prior session and effectively communicate this to fixed-income investors and shareholders to ensure all are comfortable with debt levels relative to cash, net realizable cash, domestic E&P and distributions. The analysis and communication should be ongoing and contemplate the end to current favorable debt market conditions and the eventual rise in interest rates.
Regulatory Arbitrage and Risk
Members will see the difference in how regulations impact banks currently, as certain banks will continue to bid aggressively for their business as other banks pull back. This creates “regulatory arbitrage” opportunities to reduce bank costs, but also risk as certain banks potentially dig themselves into a regulatory hole that they may have more difficulty getting out of when the regulations (e.g., higher capital and liquidity requirements) eventually start to bite. The regulatory risk is compounded by the fact that every major banking jurisdiction has a different timetable for its final interpretations on Basel III implementation and supplementary rules.
For instance, the G-SIB buffers are to be phased in with reporting beginning in 2016 and full adoption by 2019. US banks subject to the enhanced SLR will have until 2018 to comply. Thus, banks that are not yet subject to final rules similar to the US may continue to hope for the best at the expense of banks that are implementing them currently. UK rulemaking was not discussed, but they are leaning more in direction of the US.
Reg Impacts on Banking Relations
Bank of America Merrill Lynch provided an overview of the regulatory environment confronting banks, focusing on capital and liquidity provisions, and how these affect members’ bank relationships. In the pre-meeting survey just 22 percent of members indicated that their Tier 1 relationship banks had discussed the share-of-wallet implications of new bank regulations in detail with them.
KEY TAKEAWAYS
1) Strategic clients less impacted. The good news for most Tech20 members is that strategic clients will be much less affected by regulatory impacts when it comes to the largest banks servicing a wide spectrum of corporate banking needs. Good name credits in sectors that banks want to target as strategic clients will feel the regulatory impact less than lesser names that banks may no longer chose to bank, or will discourage with higher credit pricing. Accordingly, firms reliant on bank funding have more to fear than firms with ample net cash. Thus, the most significant impact on most members may be on efforts to help customers, distributors and suppliers that will feel the regulatory effects more directly.
2) Different banks will be impacted differently. Not every bank will feel the impact of regulations to the same degree or at the same time. For example, the largest banks most exposed to other financial institutions find themselves higher on the list of Global Systemically Important Bank (G-SIB), and thus subject to more of a capital buffer requirement on top of the Basel III capital ratios required of all major banks. This will make it even more expensive for them to offer capital intensive services. Banks outside the 29 G-SIB list will have a bit less capital pressure. Also, generally speaking, the US- and UK-regulated banks will face stricter regulatory burdens than the continental European banks (except the Swiss, who are also strict) and the Asian banks less strict still, according to the BAML experts. For example, while the US has still not finalized how it will implement the aforementioned G-SIB buffers, it has finalized a separate, enhanced supplementary leverage ratio, or a minimum 2 percent buffer above the 3 percent SLR mandated by Basel III for the US G-SIBs. The SLR is a ratio of Basel III defined Tier 1 capital/exposure. Further, the US has mandated via the Collins Amendment to Dodd-Frank that US banks must hold the capital equivalent to the higher of the Standardized or Advanced approach.
OUTLOOK
The easy to grasp to-do from the session was to consider increasing the mix of non-US (and UK banks) and non-GSIB banks in your bank group. Though, the potential negative implications to BAML were diffused by the message that members’ banking business with it would not be significantly impacted. Also, the oft-heard recommendation to amend and extend or renew credit agreements (5 years) to get you past the regulatory implementation pain points was repeated. It is likely not bad advice.
Taper Investing
Bank of America Merrill Lynch led the final session looking at how corporate cash managers might invest and position their portfolio during this period before rates rise.
KEY TAKEAWAYS
1) Go out to 2-3 years if you want some yield. Bank of America Merrill Lynch pointed out a strategy to pick up some yield by going out 2-3 years in duration, with the idea that the rate rise will not happen before then. You have to determine if the yield pick-up is worth that risk, which is why many members indicated they were shortening now: treasurers have a larger risk asymmetry than most portfolio managers.
2) Hope rates rise because the economy is growing. If your fear is that rates will rise sooner, rather than later, you better also believe that the economic outlook is also going to be rosier sooner. If rates go up past 3 percent because the Fed tightens ahead of economic improvement, then the US, and maybe the world may be headed for problems.
3) Rethink BBB corporate beats A-rated bank. Bank recapitalization, capital regulation and stress-testing in the US mean that banks have not been this well capitalized in a long time. They are certainly much less of a credit risk than they were in the aftermath of the crisis when this BBB-industrial-beats-a-bank thinking crystallized. Also, going down the credit spectrum in industrials can expose you now to a lot of bond-unfriendly actions, like LBOs. But even before that, you are subject to top-line growth stalling and ever increasing buybacks, which are not bond-friendly. Finally, the BBB-industrials trade is largely gone and you are just not getting compensated for the risk relative to higher-rated banks at this point.
4) Avoid treasuries. There just are not enough natural buyers to make up for the tapered Fed purchases. Balance sheet optimization by banks could make Treasuries cheaper relative to credit than currently, but you will find it difficult to get a bid when you want to sell.
5) ABS over MBS. GSE reform prospects are not good in BAML’s view, so MBS are not attractive. ABS and Agency ABS is far more attractive. If you want a liquid MBS alternative, consider mortgage pass-throughs.
OUTLOOK
As noted, the key for members looking to position their cash portfolios for rising rates is to set expectations for the first Fed rate hike and then determine your risk appetite for being wrong. If you have no risk appetite, the answer is easy: shorten up your portfolio now. But in setting your risk appetite, consider these scenarios: If you are wrong and rates rise sooner because the economy is doing better, you can consider that cash portfolio losses could well be offset by better top-line growth in the underlying business. If you are wrong and rates rise sooner than the economy should dictate, you may be in for worse problems than losses on your cash investments.
Spreading the Word on Finance
For many years an often overlooked aspect of working capital management was getting everyone in the company involved. This is important because many functions in the company don’t always realize how integral they are to the company’s broader value. One member company hired an outside consultant to help educate employees on financial matters while another used them to help create a course for senior managers to take.
KEY TAKEAWAYS
1) Reinforce link between business decisions and financial reporting with educational courses. The member described how he developed a curriculum template for a course with select groups of 25-30 senior managers to demonstrate how changes in the company’s strategy and business decisions showed up in the financials. The two-day course was supplemented with video clips to reach a broader audience.
2) Use simulation games to spark competitive learning. Another member described the effectiveness of simulations created with an outside consultant that modeled his company’s subscription-based business. These simulations were used in four-day courses with senior VPs that included competitions to see who could drive the company in the more successful direction from a financial perspective, after learning about key drivers in a subscription-based business model. The goal was to improve internal understanding of how a subscription business should perform and how this should be reflected in the stock price. The better internal people understand this, the better they can communicate this externally to customers, shareholders and stakeholders.
OUTLOOK
As treasurers take on more roles that align with strategy and planning, their ability to link financial concepts with business actions in ways that all managers (finance and non-finance) can understand improves their chances of success. This is true even in more traditional treasury activities, like educating line managers on the impact of foreign exchange on financial results and the importance of involving treasury in decisions concerning currency of billing or payment, for example. The same can be said for a cash-based view and forecast as opposed to an accounting-based one. Accordingly, treasurers should make use of available tools and templates created by peers to educate their internal business customers on treasury activities and do the same with business decisions and corporate finance activities as they move up the value chain, so that everyone can work together toward broader financial strategy and planning goals.
CONCLUSION & NEXT STEPS
Many members find themselves a bit closer to the breaking point. They are pinched between pressure from activists spurring more sophisticated and forward-looking capital analysis, planning and allocation and a US tax code forcing them to keep large piles of cash offshore. Something has to give: they can find a way to utilize more of their cash in a way that pleases investors without a tax haircut (win on tax reform or move carefully offshore) or with (if that’s what investors really want). Financial engineering and sophisticated investor relationship management may postpone the day of reckoning past the date of tax reform for some, but maybe not all. And, certainly, if the Fed messes up with tightening, it will make the situation even dicier: Would this accelerate tax reform or simply exacerbate demands on Tech cash offshore?
The Tech20’s next meeting, sponsored by BNP Paribas November 5-7, 2014, will provide an opportunity to discuss this further.