How Trump’s tax plans could hit DCM

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By:
Mark Baker
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A booming start to bond issuance in 2017 is threatened on two related fronts.


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When a lot of cash meets a lack of conviction, the primary debt capital markets typically do well. Investors, fearful of being blindsided by a poor call in the secondary markets, prefer to take a scattergun approach to primary instead, where they might at least be able to pick up some new issue premium.

The effect is all the more pronounced, of course, when the dynamic also suits the supply side – as now, for instance, with borrowers wary of future rate rises.

And so it has proved in 2017. Global DCM issuance volumes are up by about 13% so far this year, to $640 billion, according to Dealogic.

An increase was predictable given the shoddy start to 2016, but corporate and SSA issuance has seen the busiest January for four years. That flying start to the year was particularly pronounced in Asia.

The five big US corporate and investment banks that reported fourth quarter earnings this month also had much to cheer in their primary debt underwriting business lines. As a whole, the group saw DCM fees rise 23% year-on-year in the fourth quarter. JPMorgan’s rose fully 32%.

Spanner in the works

So, barring hefty increases in interest rates, is it all looking rosy in the world of DCM? Not exactly. There remains the small matter of US tax reform to throw a spanner in the works.

Much attention has been on new president Donald Trump’s talk of pushing US firms to repatriate profits, but for investment banks it is the tax treatment of debt interest payments that could end up being a bigger issue.

This is much more than a technical detail, but was oddly absent from the conference calls to discuss the results of the five CIBs this week – with one exception: Steven Chubak, an analyst at Nomura, asked Goldman Sachs CFO Harvey Schwartz what his thoughts were on the impact of any elimination of interest expense deductibility.

Schwartz batted the point away with a “too early to tell” comment, but he and his peers elsewhere have doubtless thought hard about that impact. And with good reason.

Two blows could be on the way for DCM volumes. First, a diminished willingness of US companies to use debt financing as it becomes less efficient. Second, their reduced need to do so, as they both repatriate profits and also begin to enjoy a potential lower corporate tax regime – a cut from 35% to 20% under Republican speaker Paul Ryan’s proposals and to 15% under Trump’s.

The effect could be severe. Based on analysis of IMF data on the relationship between corporate taxation and leverage, analysts at Bank of America Merrill Lynch late last year estimated that the outstanding US corporate investment-grade bond market might decline over time by 14%, or $830 billion, all else being equal.

Even more startling would be the effect of eliminating interest expense deductibility, where the analysts forecast a drop of one third in new issuance as a result.

The five banks all made generally positive noises about the near-term outlook for debt financing businesses in this month’s results calls, although some analysts have been predicting overall global bond supply to fall in 2017, even before any Trump tax reforms.

However, throw those into the mix, and DCM could look very different.