With interest rates still at historic lows, credit investors should explore every available source of return. Fraser Lundie, Co-head of Credit, and Andrey Kuznetsov, Senior Credit Analyst, explore the opportunities provided by reverse Yankees.
While issuance of reverse Yankees – corporate bonds issued in Europe by US companies – has slowed in 2017 so far, the market has grown considerably in recent years, providing opportunities for investors with flexible strategies. The year’s slow start for issuance looks set to turn around, as the tax changes proposed by the Trump administration are likely to propel this market forward.
Rise of the reverse Yankee
Yankee bonds, which are issued in the US by a foreign government or company, have been a mainstay of the US fixed income market for several decades. But in recent years, an increasing number of American companies have been doing the reverse: issuing debt in Europe. As a result, the so-called reverse Yankee market has already reached €330bn1 and is primed for further growth driven by proposed changes to US tax law.
The Trump administration has made clear its aim to change the regulatory landscape for businesses, and if the rumoured end to the tax-deductibility of interest expense on debt becomes reality, it would likely lead to further expansion of the reverse Yankee market. Why? American firms would be incentivised to issue bonds offshore in much the same way that many currently try to book profits overseas, in order to minimise the tax burden on their onshore profits.
There are also three further growth drivers for the reverse Yankee market:
- Globalisation and currency volatility are compelling many US companies to find new ways of better matching their revenue streams with costs, and issuing euro-denominated debt is one way of helping them to do so.
- The US dollar has risen against the euro by more than 20% in the past three years, making European companies attractive takeover targets for US firms. Funding at least part of such acquisitions in euros has been the preferred route for many companies.
- The Corporate Sector Purchase Programme, the European Central Bank’s initiative to buy European corporate bonds in an effort to boost the eurozone economy, combined with Europe being at an earlier stage of the monetary-easing cycle than the US, has in some cases made it cheaper for US companies to issue bonds in Europe than in their home market. This is due to the lower-rate environment and the strong performance of European credit markets, which has driven yields lower.
Advantages for investors
What does all this mean for investors? For those with the flexibility to allocate to reverse Yankees, the bonds provide a number of benefits. For example, they have considerably increased the breadth of the European credit universe, particularly for investors unable to allocate to bonds not denominated in euros. More choice means more opportunity to outperform.
The reverse Yankee market also provides access to US companies that, in many cases, demonstrate higher credit quality than their counterparts in Europe. And it provides an excellent source of portfolio diversification as US and European companies are often subject to different performance dynamics.
Perhaps the greatest benefit is that the market is home to some excellent mispricing opportunities for global investors to exploit. Relatively poorly known US firms issuing bonds in Europe are, in some cases, compelled to price new issues with an attractive spread in order to attract European investors who are unfamiliar with their businesses. Such issuers may be just as creditworthy as a similar European company whose bonds provide a significantly lower spread. For investors with an in-depth knowledge of US corporate bond issuers, they represent an excellent opportunity to boost risk-adjusted returns.
Huntsman: a reverse Yankee case study
Let’s consider Huntsman, a Texas-headquartered chemicals company that generates one-third of its revenues in North America and has a diverse global client base.
Huntsman’s capital structure provides considerable opportunity for investors with flexible mandates to benefit from mispricing opportunities. The company has a number of outstanding term loans, has issued debt in both euros and US dollars, and also has a credit-default swap contract trading on its debt.
Huntsman’s reverse Yankee bond is our preferred means of gaining exposure to the company at present as its spread is close to 100bps greater than those of its US dollar issues on a cross-currency-adjusted basis2. In the chart below, we can see that while Huntsman’s 2021 US dollar issue is providing a spread of 196bps (based on an interpolation of its 2020 and 2022 issues), its 2021 reverse Yankee is trading with a spread of 288bps.
Figure 1: The Huntsman 2021 reverse-Yankee bond provides an attractive spread pick-up relative to its comparable US dollar issue
Source: Hermes Credit, Bloomberg at February 2016.
Reverse Yankees are established in the European credit market and should grow in importance. With Trump’s proposed tax changes and Europe at an earlier stage of its monetary-easing cycle than the US, American firms are incentivised to keep issuing bonds in Europe. As the market grows, investors with an astute knowledge of US corporate issuers and the ability to allocate to these bonds should continue to uncover attractive opportunities.
1 The notional outstanding value of US country-of-risk corporate bonds issued in European currencies.
2 The spreads of bonds issued in different currencies need to be adjusted for differences in interest rates and exchange rates.