Potential effects of the new U.S. tax law have stoked concern among some industry sources that corporations might issue fewer long-duration bonds, making it tougher for corporate pension plans looking to derisk.
For plans that hit their liability-driven investment glidepath triggers and want to increase derisking, "you're currently able to buy bonds," said David Wilson, managing director, head of solutions design, Nuveen LLC, Chicago. "But we do project a substantial deficit going forward" as more plans hit their derisking marks and look for long-duration investment-grade corporates to hedge liabilities.
There's already been a decline in corporate bond issuance, according to data from the Securities Industry and Financial Markets Association. Issuance year-to-date April 30 totaled $597.8 billion, down 13.9% from the same period last year.
Changes to the U.S. tax code, enacted in late 2017, cut the corporate rate to 21% from 35% and could lead to less corporate debt being issued, increasing the imbalance between supply and demand, according to a report by investment consultant Willis Towers Watson PLC, "Pension funds and tax reform: How to deal with a double-edged sword."
"(Fixed-income) issuance has tended to be inversely related to interest rates," said the report, released late last month. "Therefore, the combination of rising rates and a lower corporate tax could deter companies from issuing debt. While these dynamics may not take effect immediately, over the long term there is reason to believe that companies could deleverage as a result."
Such deleveraging would mean DB plan sponsors looking to derisk might have to use other investment strategies beyond traditional corporate fixed income, like securitized credit, private credit and tax-exempt municipal bonds, the report said.
"Long term, I agree with Willis Towers Watson, there'll be less motivation going forward to issue long-duration corporate debt," said Nuveen's Mr. Wilson. "There's less of a tax-deduction incentive to (issue debt), which will have a negative impact on the long end of the curve.
"And along with that, it's expected there will be significantly higher rates from the Federal Reserve. … As rates rise, liability rates fall, so you'd expect more plans to hit their glidepaths to derisk at a time when issuance is falling. ... We do expect a lack of supply for late entrants into hedging."
The new tax law also will allow companies to make tax-deductible plan contributions under the 2017 rate until Sept. 18, saving the companies further on their overall taxes. That, Mr. Wilson said, will have even more corporate plans hitting their derisking triggers, creating yet more demand for long corporate bonds.