Ten financing ideas for the end of QE

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An end to Quantitative Easing could pose a number of corporate financing challenges. The risks include rising medium-to-long-term interest rates, wider credit spreads and higher yields on risk assets, writes Eu-Jin Ang, Senior Director, Corporate Advisory, RBS.

1. Good treasury management principles still apply. Debt maturities should be well distributed to avoid the need to refinance a lot at once – and the risk this could overlap with an end to QE.

2. Corporate issuers should be ready to act while the loan and capital markets remain open. There may be a need to act urgently if there is maturing debt that requires refinancing, or plans are afoot for actions such as share buybacks or dividend recapitalisations.

3. Consider holding more cash and liquidity to weather potential storms.

4. Remember a steeper yield curve affects the relative costs of debt with different tenors. This will happen if short-term interest rates and yields remain low as loose monetary policy is maintained, but long-term rates rise in anticipation of QE ending.

This could affect the economics of infrastructure projects, where long-term debt is used to fund and match fixed cashflows. More expensive debt will squeeze margins and raise the Weighted Average Cost of Capital (WACC), to the point that a project’s Internal Rate of Return falls below it. The project would then become economically unfeasible.

Locking in the current costs of long-term funding, for example by pre hedging, may be worth considering.

5. Investigate issuing floating rate notes (FRNs). Fears QE was coming to a close caused a spike in bond yields in June and July and created a renewed appetite for FRNs among bond investors. This is because interest rate duration is low in FRNs.).

When such concerns emerged earlier this year, the US Treasury and companies such as Petrobas and Glencore Xstrata were able to tap the FRN market and achieve tighter margins.

6. Convertible bonds. This may be a way to diversify funding sources and take advantage of heightened stock market volatility caused by uncertainty over tapering speeds.

The primary market is currently pricing issues at or above historic equity volatility. This raises the embedded option value in a convertible, lowering its bond cash coupons. The rising yield environment makes these low coupons increasingly attractive for issuers. If share prices are also elevated, higher conversion prices make the case even more compelling. It is possible for a company to prepare and execute a convertible bond within the duration of a share price rally, as light documentation means issuers can react quickly to market conditions. Even if share prices are fickle in responding to central bank announcements, fast execution – in typically two to three hours – allows issuers to tap investors with minimal market risk.

7. Currency markets will be affected. Areas highly sensitive to spot FX rates include foreign investments or acquisitions yet to be completed, net asset values, foreign earnings that need to be translated, as well as credit rating and covenant metrics

8. Be mindful of currency impacts when planning corporate debt capital market strategies. Corporates need to consider the impact on the USD and other currencies from QE tapering. Demand and supply of currencies affects the spreads of cross-currency basis swaps (CCS), which are vital when swapping debt into different currencies.

For example, tighter US monetary policy is likely to increase demand for USD and improve the cost advantage of USD-denominated debt swapped into EUR or GBP, as compared to debt originally denominated in EUR or GBP.

This means the choice of currencies for near-to-medium term issuance needs to be considered carefully.

9. Manage core banking relationships closely, especially non-domestic ones. The possibility QE will taper, end or be unwound at different speeds around the world might make banks focus even more on domestic markets, exacerbating the fragmentation of finance along national or regional lines. Scarcer liquidity is more likely to be lent locally, while rising yields could encourage investors to buy domestic government debt and corporate bonds. It becomes more important than ever to manage how ancillary income is distributed among house banks.

10. There might be a silver lining for corporates with large pension liabilities. These have been hit badly by loose monetary policy/low yields, increasing the funding requirements for the company.

QE tapering or ending reverses this and reduces both pension liabilities and deficits (since plan assets are unlikely to be all bonds, or have the same duration as liabilities). Pension deficits are taken into account by rating agencies when calculating adjusted net debt in leverage metrics, so improved headroom helps preserve credit ratings and financial flexibility.

If companies are looking to re-allocate assets (for example by switching from bonds to equities) or to fund deficits via the capital markets, it might be prudent to act sooner rather than later.


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