MTNs drift on market uncertainty

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Kristine Falkgard

Issuance is down in the medium-term note market. September's terrorist attacks have left the market nursing its wounds. Fears about liquidity and concerns about widening spreads have persuaded many issuers and investors to stay away.
Triple-A issuers are an exception. Investors' flight to quality has made it an excellent time for triple-As to place paper and, despite many triple-A issuers already exceeding their funding targets for 2001, high-grade borrowers are flocking to the market
But for the lower-rated issuers life is more difficult. According to MTNWare, Triple-B issuance fell from a high of $13 billion in April this year to just $2.45 billion in September 2001 - its lowest level this year. Those lower-rated issuers that can afford to stay out of the market are doing so and, in the private corporate sector, issuance slumped to $2.83 billion in the first four weeks after September 11, a fall of 50% on the previous four weeks.
Christian Kammann, group treasurer at Heidelberger Zement, a triple-B German materials company, has not tapped the MTN market since June 2001 but he does not expect a return to the market soon. "We are getting a lot of enquiry at the moment but the spread development is quite exaggerated," he says. "We are not different from any other issuer and have decided to sit back and watch things go by. We have ample liquidity reserves and will take our pick of what is available."

But this attitude worries investors. Javier Estrada, head of corporate fixed income at AB Asesores, Spain's biggest financial consulting group, has moved much of his portfolio into utilities and other defensive issuers. He is concerned that too many corporate issuers are waiting for spreads to tighten.
Estrada says: "The worrying thing now is the big line of corporate issuers waiting to get into the market. We have decided that the best plan of action is to just hold tight and wait and see what happens. I admit that if I now bought the same products I saw in the market before the attack everything would be cheaper but there are just too many issuers in the pipeline."
Gavin Eddy, head of MTNs at UBS Warburg, the second-most active bookrunner of private MTN trades since September 11, sympathizes with Estrada. September is usually a big month for issuers to get funding and Eddy believes this is a worry. He says: "Investors are concerned about credit spreads becoming even wider as issuers queue up and fight to get paper placed. Investors have a big pool of money that they need to place immediately and they want to put that somewhere that does not blow out by 20 or 30 basis points in three or four days' time."
But investor focus is not just on ratings. The US has felt the biggest pain in terms of slowing economic activity and the market is wary of what it is buying in the US. Rabbani Wahhab, joint head of fixed-income strategy at Aberdeen Asset Management, is particularly worried about US investment banks and will not buy into this sector until it has seen sufficient cost reforms.
He says: "Utilities, triple-As and financials are doing very well. But we are avoiding US investment banks. We have not seen the required cut-backs in costs, via staff shedding, that is required in the current environment. When we see this, we will feel more confident about increasing our exposure to this sector."
Triple-A issuance in the MTN market reached $41.74 billion in September - almost double that of August. And Japanese investors are driving this demand in the private market. The market share of yen issuance increased by 16% in the first four weeks after the US attack, compared with the four weeks before. A weakening dollar has stimulated demand for yen-denominated power reverse dual currency-linked notes. And investors buying this structure are only willing to consider triple-As.
Kristine Falkgard is head of international funding at Kommunalbanken, a triple-A Norwegian local-government funding agency. The agency tapped the private MTN market 22 times in the five weeks after the attack and all but one of its notes came in yen. Falkgard believes that the Japanese investors were the first to return to the market after the New York tragedy and this enabled them to find attractive levels.
She says: "The Japanese are less affected by the politics of war. They have their own problems. The Japanese trusts have large amounts to invest and they need to put this money to work right away. They are keen to put a risk on the coupon and target triple-As to reduce further credit risk. But when you consider the low interest rate environment that they operate in, this is not such a big risk for them.
"If we were not able to fund at the levels we have done since the attack then we would not have come to the market. We have the liquidity reserves to be able to stay out of the market for at least a year if we have to."
Yet for corporates the future looks bleak. Wahhab at Aberdeen Asset Management says: "We are now in the next phase. There is extreme widening and contracting in some sectors. Those who felt that the global economy was showing real signs of improving have been dealt a serious blow.
The last thing that companies, in sectors such as leisure and industrials had wanted was a fall-off in revenues, and it is these types of issuers that will get stung by the widening spreads." Eddy at UBS agrees. "It will get worse before it gets better," he says "We will start to see more polarization in the market. The triple-As and double-A financials will do really well but at the other end the weakening and deteriorating credits will be plagued by widening spreads."

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