In the past year, the Eurobond market has doubled, despite a change in U.S. tax law that took away some of that market's advantages.
When Congress approved the elimination of the 30-percent foreign withholding tax last summer, a number of U.S. investment bankers expected the international bond market to return from offshore markets to Wall Street where it used to reside.
Instead, business has been booming in both markets.
According to statistics released by the Organization for Economic Cooperation and Development in Paris, Eurobond offerings during the first half of 1984 amounted to $21 billion. In the fourth quarter, they shot up to $27.9 billion and have continued to increase since. In the first two quarters of this year, new issues totaled $66 billion. For 1984 as a whole, Eurobonds raised $81.7 billion in new capital. This year, offerings are running at an annual rate of $130 billion. That compares with just $50 billion in 1983.
On the other hand, however, foreign investors bought about $12 billion net in U.S. corporate bonds in 1984 -- up from $918 million the previous year -- and $21 billion net in Treasury debt, compared with $5 billion in 1983.
Eurobonds are issues placed simultaneously on the markets of at least two countries through international syndicates of financial institutions of several countries. The bonds are denominated in a currency that is not necessarily that of either country. In fact, more than three quarters of the issues are in U.S. dollars, although other currencies are gaining favor slowly.
Concerned about the possibility of tax evasion by U.S. citizens abroad who sometimes failed to report interest income from Eurobonds and desirous of opening up capital markets to fund its own debt at lower cost, the Treasury last year asked Congress to repeal the 30 percent withholding tax. It was also expected by some American investment bankers that the move would shift the international bond market back to Wall Street.
Foreigners would buy in U.S. markets without fear of tax consequences. The Wall Street Journal quoted estimates by investment bankers of between $50 billion and $200 billion that could be expected to enter the country. West Germany, fearful of such a westward flow of capital, rescinded its own 25 percent tax on debt held abroad. Other countries also liberalized their markets.
Michael von Clemm, London-based chairman of Credit Suisse, observed last month in Zurich, "It was said the removal of withholding would be the death blow to the Eurobond market, but U.S. issuers operate with different practices abroad. We try to sell bonds in small lots to many investors whereas institutional investors dominate in the U.S."
The Eurobond market did not languish following repeal. The Treasury's refusal to allow bearer bonds, which provide investors with an anonymity that some desire, assured its survival.
The Eurobond market is now the largest capital market outside the U.S. Treasury. Because the securities are issued outside the borrower's country, the market is largely unregulated and largely untaxed. This means that borrowers can raise money more quickly, more easily and more economically than at home. Many blue-chip American corporations, as well as government agencies, now routinely borrow abroad. The center for multinational lending is London, but the top 10 underwriters are dominated by U.S. companies. Credit Suisse, First Boston and Salomon Brothers are among the biggest players.
Eurobonds appeal to investors because of their safety -- some are collateralized by U.S. government securities -- and their anonymity. Issued in bearer form, they afford protection from the peeping eye of the tax collector. To spare foreigners from having to pay a 30 percent withholding tax on bond interest to the U.S. government, American companies became accustomed to making their offerings through offshore subsidiaries, particularly from Caribbean tax havens like the Netherland Antilles. There were 30,000 paper subsidiaries on Curacao alone before repeal.
Since repeal, however, in the Antilles, through which billions of dollars passed, only a handful of offerings have been issued, said Edward Pieteresz, director of industrial promotion for the Netherlands Antilles economic mission in New York.
Repeal has had an impact on yield relationships, making U.S. governments more attractive. The internationalization of markets has narrowed spreads between U.S. and Euro issues, so that where there was once as much as three percentage points difference, the margin is now between 10 and 125 basis points, according to von Clemm.
"The size of the Euromarket would have been even larger if there had been no repeal," said John Lipsky and Nick Sargen, vice presidents for international bond research at Salomon Brothers in New York. Yet all observers say market factors have been far more important for the Euromarket. This year's bond boom was fueled primarily by increased demand for capital, the strong dollar and the change in interest rates. As such, a slide in U.S. currency combined with a drop in interest rates could make dollar-denominated bonds less attractive to potential investors. Shearson Lehman Brothers International in London expects to see less-aggressive buying of foreign securities in the future.
Should the dollar lose appeal for investors, U.S. corporations are prepared to issue debt in other currencies. The Federal National Mortgage Association did a $200 million offering in Euro-yen this year. Ten percent of Fannie Mae's corporate debt is now held by foreigners, compared with 16 percent of all Treasury debt. Since repeal of withholding, Fannie Mae -- the largest supplier of mortgage funds in the country -- has raised approximately $490 million in foreign markets, and it intends to do a lot more in both Europe and Japan, according to its president, Mark J. Riedy.
Riedy was one of the participants at a recent Zurich conference on Euro-American mortgage capital markets sponsored by the National Council of Savings Institutions. As newcomers to the Euromarkets, savings institutions last year raised over $2 billion abroad. A dozen or more savings and loans successfully marketed their notes, partly collateralized by U.S. government securities, despite the financial scandals that rocked the industry.
This was also despite the fact that this debt must be issued in registered form, targeted to institutions. Last September the Treasury ruled that bearer securities backed by government securities would be denied favorable tax treatment.
Explaining the various options for financing, Gilman C. Gunn of Banque Paribas Capital Markets in London noted, "The savings and loan industry is about as domestic as you can get. Now it's thinking of diversifying out of the dollar. It's mindboggling."
Another participant put it more earthily: "What internationalization of markets means in a nutshell is that the African dictator who stashes his money in a Swiss bank may now be financing farmhouses in Minnesota."