US corporates tap euros for cheap debt and FX hedging

US corporates have flocked to the euro debt market, reversing a three-year decline in reverse Yankee issuance, as blue-chip firms take advantage of favourable funding costs and lock in cheap foreign exchange hedges on their overseas assets.

More than €52 billion-equivalent ($58 billion) of euro-denominated ‘reverse Yankee’ bonds have been issued by US corporates this year, according to data provided by Deutsche Bank. Supply is already more than 20% up on full-year 2023 and is on track to be the highest since 2020, when Covid-related funding saw €70 billion issued. The instruments represent 20% of US corporate debt issued this year versus a historic average of 10–15%.

This jump reflects lower funding costs in euro bond markets. Debt capital markets (DCM) bankers remain bullish on a continuation of the trend into year-end.

“A lot of the dynamics that have drawn people over here are still there today. We still have the rate differential, and the market is still offering competitive pricing. So, I don’t expect it to go away, even if overall issuance of bonds will probably slow down,” says Sam Wareham, director for DCM syndicate at Deutsche Bank.

Reverse Yankees see US corporates raise debt in foreign currency bond markets – typically euro or sterling. Johnson & Johnson, Procter & Gamble and Coca-Cola are among the blue-chip names that have tapped the euro market this year.

The market is largely driven by diverging monetary policies, which can create more favourable funding levels outside of the US. Also at play is the cross-currency basis, which determines the cost to swap proceeds back to the home currency.

The European Central Bank moved earlier than the Federal Reserve to cut interest rates. US SOFR rates hovered above 5.3% in August while the equivalent euro short-term funding rate, or €STR was around 3.6%. Those differentials are reflected in corporate bond yield curves. S&P’s euro investment grade bond index currently yields 3.57%, compared to 5.08% for an equivalent US corporate bond index consisting of S&P 500 issuers. The indexes have an average duration of four years.

US firms raising funds in euro markets can pay coupons around 2% lower compared to US dollar-denominated debt, depending on maturity, DCM bankers say.

“The reverse Yankee issuance has been the biggest tool to exploit the different, longer-dated curves and then swapping the euros back to dollars for these companies,” says Garth Appelt, head of derivatives, FX and emerging markets macro trading at Mizuho Americas.

A tightening EUR/USD cross-currency basis has added to the upbeat economics. For example, the five-year EUR/USD cross-currency basis is currently around 10 basis points, down from 25bp in November 2023, according to Dealogic.

In addition to cheap funding, blue-chip companies are eyeing the reverse Yankee market to achieve a natural foreign exchange hedge on overseas assets generating euro revenues. By funding in euros, any appreciation or depreciation against the dollar will impact both assets and liabilities, reducing overall FX exposures.

“If you are a US company and you have European assets, the most conservative, least-risk financing strategy is to finance those assets using euro-denominated debt,” says Reuben Daniels, managing director and global head of investment banking at Chatham Financial.

Corporates in Europe and Asia have long issued US-dollar denominated debt – or Yankees – to take advantage of a deep and liquid US bond market. Last year, non-financial corporates issued more than $100 billion of the instruments. Yet the reverse trade is typically smaller, reflecting thinner liquidity in euro debt markets.

Traders say this is changing, with US corporates finding renewed appetite from large European investors such as insurance companies, which naturally hold long-term European liabilities.

“You’ve had a demand side in Europe because of a dearth of longer-term credit bonds from the European insurers, the European banks, European asset managers and the European reinsurance companies,” says Mizuho’s Appelt.

Investors have recently shown interest in eight- to 12-year maturities, moving to 20- to 30-years for the most highly rated names.

Maria-Lisa Farmakidis, executive director for debt capital markets origination at Standard Chartered, expects demand from European investors will continue to ramp up, ensuring the euro market remains an attractive route for US issuers to raise debt alongside vanilla US dollar offerings.

“Concurrent [US dollar and euro] trades are becoming very standard, and US companies are able to achieve the size of the funding needs, investor diversification, and balancing out their maturity structure by using the euro market,” she adds.

For example, Johnson & Johnson raised €2.5 billion in May alongside a $4 billion US debt offer. Earlier this month, Coca-Cola raised €1 billion in euros alongside $3 billion of vanilla US debt. The multi-tranche deal included 13- and 29-year euro instruments of €500 million each, with order books on the transactions six times subscribed, according to Farmakidis.

Editing by Helen Bartholomew