BofA, CAG Write on Repatriation: Funding Pressure, Offshore Reduced

Two new publications discuss the possibility of the “​repatriation” of offshore corporate profits, its mechanics and the potential impact on the cash and money fund markets. The first, a “Liquid Insight” published by Bank of America Merrill Lynch, is entitled, “Repatriation Could Result in Modest USD Funding Pressure,” while the second, written by Capital Advisors Group, is entitled, “The Trump Tax Plan and Its Implications for Cash Portfolios.” BofAML’​s Mark Cabana explains, “​As Washington has increasingly focused on tax reform, clients have asked questions about how repatriation might impact the front end of the US rates curve. While there are still many unknown elements of the plan, we believe repatriation could provide modest upward USD funding pressure for foreign banks but likely leave the overall stock of commercial paper outstanding little changed.” We excerpt from both of these updates below.

Bank of America Merrill Lynch’​s piece, which cites some Crane Data statistics on “​offshore” money market fund holdings, continues, “The modest bank funding pressure could come as corporates trim unsecured bank lending, both outright and through offshore money market mutual funds (​MMF). This could modestly widen short-​dated FRA-​OIS spreads by 2-​6bp. It could also contribute to more negative levels of the EURUSD and JPYUSD cross currency basis given EU and Japanese financials’ exposure to offshore prime MMF…. A potential repatriation next year could add to existing expected funding pressures as the Treasury boosts its cash balance and the Fed’​s balance-​sheet unwinds.”

They say, “It is unclear how long after any tax reform legislation would be passed that the one-​time levy might take effect and when offshore cash might come back onshore. During the last repatriation episode in 2005, there was a 1Y window in which foreign profits could be repatriated, which led to $​312bn being brought back onshore. We currently assume that most of the offshore earnings would be brought back relatively soon after the mandatory tax, given there is limited incentive to keep any excess funds offshore. Although the prospects for broad tax reform are uncertain, we continue to believe that international tax reform resulting in some form of repatriation has a reasonable chance of success.”

Cabana states, “​Estimates for the total size of US corporate offshore holdings generally range from $​1.​5-​3tn … leaving at least $​1.​5tn offshore that could potentially be repatriated…. In our view, any near-​term offshore repatriation should serve as a tailwind to the US dollar and also tighten corporate credit spreads while also leading to a modest amount of upward funding pressure. We do not expect any offshore USD repatriation to result in a meaningful decline of corporate supply at the very front-​end of the curve but could see greater supply constrains further out on the corporate credit curve.”

He tells us, “While corporate credit supply is slated to contract with repatriation, we think the overall impact on the commercial paper market will likely be limited. CP programs serve as cheap sources of funding where issuers generally aim to maintain stable program sizes due to their high turnover and investors prefer to roll maturities with the same issuer. During the 2005 repatriation, the amount of commercial paper outstanding increased as non-​financial CP outstanding rose $​10bn, while financial CP grew $​57bn.”

The Merrill piece adds, “Repatriation could potentially lead to upward pressure on bank funding costs, primarily through reduced holdings in ST investments, including deposits, CP, or offshore prime MMF holdings. We expect any offshore prime MMF investments to be shifted into government MMF as they are brought back onshore to avoid any gate or fee provisions in the US. Offshore prime USD money funds hold $​313bn in assets with $​242bn in CP (​mostly financial), CD, and time deposits, according to Crane…. Eurozone, Japanese, and Canadian bank issuance comprise the largest portion of offshore USD MMF holdings at $​57, $​32, and $​31bn, respectively (​Chart of the Day). The largest funding impact would likely be seen in the most exposed foreign banks, in our view.”

Finally, they say, “The withdrawal of offshore funding could result in funding pressures similar to, but on a much smaller scale than, what occurred with 2a-​7 MMF reform last year. Between end-​May and October 2016, prime money market mutual fund CP and CD holdings declined $​485bn while 3M LIBOR-​OIS spreads widened 15bp…. Assuming a similar relationship applied to offshore USD MMF withdrawals or to offshore CP/​CD redemptions, we think 3M LIBOR-​OIS spreads could widen 2-​6bp in repatriation…. We expect impacted foreign financial institutions to eventually find other sources of USD funding and thus lead to a relatively short-​lived increase in funding strains, similar to what was seen with 2a-​7 MMF reform.”

Capital Advisors’ new paper, written by Lance Pan, tells us, “​The Republican bill represents a starting point for tax and budget negotiations. While details are lacking, the current plan offers some interesting angles for market participants to think about their liquidity investment strategies. We highlighted parts of the bill relevant to corporate cash investors and their potential impact on issuers and investors in the short-​term debt market. We advise our readers to be patient, stay liquid and think strategically during this waiting period.”

They explain, “Since the tax framework touches many important subjects that impact the corporate treasury management community, we want to keep the dialog going by addressing the plan’​s potential impact on market liquidity and treasury investment strategies. Although the plan represents an early blueprint of the finished legislation, understanding the key issues at stake may assist our readers with their internal discussions and perhaps advanced planning.”

Regarding “Repatriation of offshore cash at a reduced tax rate,” Pan says, “Institutional cash investors are keenly interested in the movement of the stockpiles of cash and liquid investments stashed offshore by foreign subsidiaries of US companies. The tax plan proposes a territorial system to tax US corporations only on domestic earnings. It offers partial exemption on foreign earnings and full exemption on dividends from foreign subsidiaries. Accumulated untaxed earnings offshore will be treated as already repatriated and subject at an unspecified, presumably low, tax rate. The repatriation tax will be spread over several years.”

He adds, “The tax plan did not specify the repatriation rate, the scope, or the timeframe it will be applied, but it is apparent that the “​repatriation tax” will be mandatory on all accumulated earnings and that it will be lower than the 20% domestic rate. An earlier Republican tax plan suggested 10% for cash repatriation. Companies that hold significant cash positions offshore, including pharmaceutical and technology companies, likely already have strategies in anticipation of these changes. Such strategies may include keeping their offshore portfolios liquid to bring it onshore for capital expenditures, equity and bond buybacks, mergers and acquisitions and other planned activities.”

Finally, the CAG piece comments, “Together with repatriation of offshore cash, the implication of this tax provision is that the market for offshore investments will be reduced meaningfully as cash moves back onshore and loopholes are closed. Providers of offshore investments, such as non-​US money market funds and banks borrowing Eurodollar deposits, should be prepared for this wave of asset migration.”