Falling yields drive yankee issues

A EUROMONEY SURVEY - MARCH 1996

Borrowers pile up the yankees

As US interest rates approach their lowest levels in more than two decades, foreign borrowers are queuing up to raise capital. American investors, for their part, are snapping up long-term bonds and bonds issued by lesser credits. The People's Republic of China $400 million yankee issue in January - $100 million for a stunning 100 years - has been the most dramatic demonstration of this convergence of interests to date. Public bond offerings by foreign issuers in the US are known as yankee bonds.

This type of issuance should continue in the near term, as most economists believe interest rates will remain low for the next several months - and should decline further if a budget compromise is reached in Washington - before perhaps beginning to rise as the November presidential election approaches. cs First Boston is advising clients to raise funds during the first half of the year. In February, CSFB estimated there were $10 billion to $15 billion in yankee issues ready to come to market and predicted "a surge of issuance as rates decline".

During the past six years, according to the Federal Reserve, foreign non-financial borrowers placed $170 billion of public and private bonds in the US - nearly four times the volume issued during all of the 1980s and taking the total amount outstanding to $264 billion last September.

Annual volume has fluctuated wildly, soaring to $28.7 billion in 1993 when interest rates last fell towards record low territory; plunging to $15.8 billion in 1994 when rates rose; then rebounding to $22.2 billion in 1995 when rates again declined, according to Merrill Lynch. The Federal Reserve reports that total foreign bonds in the US at year-end 1994 amounted to $234.6 billion, a little more than double the amount at the end of 1990.

But issuance volume is not the only story. Until recently, only the most creditworthy foreign names were able to tap the US bond market, the largest pool of capital in the world. Yankee offerings were mainly limited to Canadian provinces, supranationals such as the World Bank and triple-A rated governments and corporations. But as long-term US rates have fallen, and some barriers to entry removed, many more borrowers have entered the fray. By some estimates, single-A and lesser credits accounted for 60% of last year's issues (of which 80% were for 10 years or longer).

The introduction of Rule 144a in April 1990 really opened the door, allowing issuers to offer bonds to large US institutional investors without registering the offering with the Securities and Exchange Commission (SEC). This exemption greatly reduces the time, expense and disclosure required, while extending the benefits of underwriting and secondary-market trading to these quasi-private placements.

The adoption of Rule 144a also helped increase awareness among foreign issuers of the US bond market's unique attractions. "Many can tap 20-, 30- and even 100-year maturities at costs not achievable anywhere else in the world," notes John Massad, vice president in the fixed-income syndicate at JP Morgan. "That's a clear advantage." In addition, he says, "US investors tend to be much more analytical in their approach to credit and more open to complex structures", such as subordination and perpetual debt, which are difficult to place in the Eurobond market.

By the same token, US investors are prepared to analyze and accept weaker credits, single-A and triple-B ratings, which rank at the bottom of the investment-grade universe. Conversely, Eurobond investors usually will not buy triple-B names or unfamiliar names. But the yankee bond market is not open to all and still confers prestige on first-time issuers. As Massad points out, many of these issuers have made a "strategic decision to establish themselves as premier borrowers in the biggest fixed-income market in the world as a means to access new investors".

With long-term US rates at levels rarely seen in the past 30 years, eligible foreign borrowers have an opportunity to lock in low-cost funding, extend debt maturity and pre-finance some or all of their capital needs for the next few years. Making the most of this opportunity, some recent issuers have used put options to trim the cost of borrowing further. William Battey, head of the yankee new-issue desk at CSFB, estimates that a 30-year issue with a 10-year put for a single-A or strong triple-B credit might save it about 10 basis points (bp). Others have maximized their borrowing capability by arranging multi-tranche issues, reaching different investor groups at different maturities.

On the demand side, US investors are becoming increasingly receptive to foreign names. In a recent survey of the 400 most active US institutional investors, JP Morgan found that foreign bonds now account for between 9% and 10% of the average portfolio, compared with 4% to 5% just three years ago. New York bankers also report growing interest from fund managers throughout the US, although they can pose educational and geographical challenges. "Some ask, 'Where's Malaysia?'" says one underwriter.

One reason for this interest is a relative decline in the volume of domestic bond issues, especially by US industrials. This reflects advance financings in 1993 when interest rates last hit bottom and stronger cash flow due to restructuring, consolidation and economic growth. In these circumstances, Massad says, "investors are looking for new ways to diversify their credit exposure and they have looked overseas". Meanwhile, liquidity is mounting and will remain an important factor. According to CSFB, a record $66 billion of US bonds will mature this year, followed by more than $75 billion in each of the next two years.

But the most powerful force behind increased demand has been a drive by US fund managers to boost returns in hopes of outperforming the benchmark indices. Last year's events illustrate the dynamics at work.

The year began with high and volatile rates, in the shadow of the Mexican financial crisis. A flight to quality by investors allowed only top-rated foreign credits to tap the market. But a 200bp rally then drove prices higher and yields and spreads lower, with yankee bonds ultimately outperforming domestic corporate bonds. As fund managers scrambled to catch up (often unsuccessfully), they were increasingly willing to buy higher-yielding, longer-maturity issues from lesser credits.
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