February 13, 2017 / 3:11 AM / 6 months ago

US issuers rush to sell Formosa bonds before rule change

* US blue chips head for Taiwan to lock in flexible funding terms

By Daniel Stanton

SINGAPORE, Feb 13 (IFR) - Three US blue chips headed to Taiwan's Formosa bond market last week in a rush to lock in flexible funding ahead of changes in local regulations and a potential shake-up in US tax rules.

Verizon Communications issued a $1.475 billion 30-year non-call three bond at 4.95 percent, the largest Formosa issue of the year so far. Also last week, Apple was rumoured to be sounding investors for a potential $1 billion 30 non-call three, indicated at a yield in the 4.3 percent area, and Pfizer was heard to be eyeing the market, too.

Global issuers are rushing to Taiwan before a local rule change in March that will effectively prevent them from offering securities with call dates of less than five years. However, US companies have an additional incentive to lock in the most flexible terms possible, with potential changes to the US tax code looming over the horizon.

"A lot of issuers are thinking they want to get ahead of this," said a foreign banker. "If something changes in the US tax rules, they can call back their bonds later."

Many US multinationals keep large piles of cash offshore to limit corporate tax payments and sell bonds to fund dividend payments or share buybacks.

However, proposals to cut the US corporate tax rate and remove the deductibility of interest payments against income are likely to spur them to repatriate their cash and potentially reduce bond issuance.

Such proposals are unlikely to become law before the end of this year, if at all, but, in the meantime, yield-hungry Taiwanese investors remain an attractive alternative source of US dollar funding.

The Formosa market relies heavily on local life insurers, and foreign issuance has rocketed since 2014, when Taiwan's Financial Services Commission reclassified Formosa bonds as domestic debt. Taiwanese insurers, which cannot invest more than 45 percent of their assets in foreign bonds, were, therefore, freed up to buy more dollar bonds listed in Taiwan.

CALLING TIME Insurance investors typically prefer long maturities and the most popular tenor in the Formosa market is 30 years, but most bonds have call options, most commonly at three years.

Still, the structure of Formosa bonds is about to change. Last month, the FSC said it would prohibit Taiwanese insurance companies from buying bonds with call options earlier than five years.

Since insurers are, by far, the largest buyers of Formosa bonds with about an 80 percent share of all outstanding issues, according to a November estimate by asset manager PIMCO, issuers are expected to stick to non-call five structures after the new rule takes effect on March 25.

That means US corporate issuers, in particular, are trying to take advantage of the short-dated call options available in the Formosa market while they can.

That may also mean the mix of issuers looking to court Taiwanese investors may change after March.

"I don't think it will mean that we get fewer US corporates issuing into the Formosa market since the economics for them to issue dollars from an economic standpoint is still the most attractive," said Rick Chan, EVP and portfolio manager, interest rate derivatives, at PIMCO.

"There is a potential that it may be different names. We have seen a decrease in Formosa bond issuance from US financials with the slack being made up from Middle East issuers and other corporates. Pfizer, Apple and Vodafone are all working on potential deals this week, for example. The binding constraint will be more from the demand side."

However, another mooted rule change is expected to encourage issues from lower-rated names.

Currently, it is impractical for life insurers to buy Formosa rated below Single A, as there are restrictions on how much lower-rated paper they can purchase. However, it is expected that requirement will be eased and it will soon be practical for them to buy Formosa rated BBB+ and above.

That could be good news for some foreign financial issuers that want to raise capital in Taiwan, as they are now allowed to sell Tier 2 bonds there up to the same amount they have outstanding in senior bonds in the Formosa market.

A head of DCM at a Taiwanese securities house said the huge expected supply of primary deals meant that investors could afford to be selective when it came to yields and industry sectors.

"The market will continuously grow, while the demand still remains strong," said the DCM head. "However, investors' appetites for those foreign-denominated notes have almost reached their portfolio limit."

US dollar-denominated Formosa bonds tend to price in line with issues in the US dollar market, but undervalue the call option, making them relatively cheap for issuers. In theory, bonds with an embedded call option ought to pay a higher yield than those without, since issuers should pay extra for the option to redeem early and investors ought to be compensated for having their expected flow of coupon payments cut short.

Investors in Taiwan and Asia, in general, have tended to take the view that, if a 30-year bond is called after three years, the extra yield over a typical three-year issue is compensation enough.

Formosa bond issues are typically sized to meet demand, and investors usually buy and hold. (Reporting by Daniel Stanton; Editing by Vincent Baby and Steve Garton)

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