Change font size:   

 
No. 6: If you don’t give it to me you’ll only lend it to someone else and look where that got us

No. 6: If you don’t give it to me you’ll only lend it to someone else and look where that got us

10 reasons to tell your boss you deserve a bonus

The US treasury market reaches breaking point

The US treasury market reaches breaking point

The structural issue that could cause the world's market of last resort to grind to a halt

weeklyFiXLiquid real estate
Skip Navigation LinksHome :: Back Issues :: Mind the step up

June 2001

Mind the step up





Just when bond investors thought it was safe to go back into the telecom sector, Moody's dropped a bombshell. By downgrading British Telecom's long term debt two notches to Baa1 last month, it threw a sector showing glimmers of recovery into disarray. Most astonishing to investors and galling to BT's management was the fact that Moody's chose May 10, the day BT announced its rights issue - the lynchpin of its debt reduction plans - to break the bad news, fuelling speculation that it was privy to particularly damming information about the company.
It wasn't that the market hadn't expected the downgrade at all - earlier that day, Standard&Poor's had taken BT down a peg to A- and placed it on negative outlook - but the severity of Moody's action caught it off guard. BT had been making all the right noises: besides committing to the largest ever rights issue, expected to raise £5.9 billion, it had made progress with the demerger of BT Wireless, found a buyer for Yell, its directories business, appointed a new CEO and suspended dividend payments for the year.
A number of developments had fostered the belief that the whole sector was getting back on track and the bulk of the bad news was over. Bond investors happily bought high yielding telecom bonds, reasoning they would never be this cheap again. April saw the best month's performance for the industry since January 2000. According to Lehman Brothers, telecom companies outperformed the euro aggregate corporate index with a 1.46% excess return, against 0.36% in March.
"In terms of credit fundamentals, not much has changed," says Bradley Bugg, telecom credit analyst at Dresdner Kleinwort Wasserstein. But analysts say that there is definitely more optimism in the air, due to three main factors. Firstly, since the jumbo deal from France Telecom in March, there has been little new issuance and few deals are in the pipeline. Deutsche Telekom's long anticipated issue of between e5 and e8 billion is expected in the next few months. It's also possible that Telecom Italia might issue.
But there are no giant-sized deals to come. This relative drought has kept spreads buoyant. "A lot of the widening that we've seen was caused by the fact that there was a tremendous amount of issuance in the second half of last year and the first quarter of this," says Andrei Gorodilov, European telecom credit analyst at CSFB.
       

View graph.
There have also been signs of a more favourable sentiment towards telecom shares. At any rate, they have stopped falling. Though credit analysts are often reluctant to posit a direct link between stock prices and bond spreads, there is an unavoidable correlation here. Telecom companies need to continue de-leveraging and one of the major ways they can do this is via the equity market.
Thirdly, investors have become much more comfortable with the fact that, though telcos have ventured a long way into the red, they aren't going to go bankrupt overnight. Traders claim to have seen little forced selling by portfolio managers not able to hold Baa1 credit in the light of the BT downgrade. "Some people had extreme expectations that these companies were going to collapse," says Gorodilov. "The market now thinks that they can sustain this level of debt for a little longer and remain investment grade."
For BT, this was a particular ambition in the light of the coupon step up language it included in its most recent bond, widely perceived to offer the strongest protection of any telecom paper. Moody's verdict triggers a 25 basis point coupon kicker which will apply to its dollar, sterling and euro denominated bonds beginning at the next coupon date. For the dollar notes this is June 15 2001, for euro February 15 2002 and for sterling December 7 2001. If it ends up meeting all of these, interest payments will increase by around £200 million a year.
Opinions are divided over whether Moody's was right to be quite so harsh. "BT has the weakest business profile of any of the telecoms," says one analyst. "It could merge with a water or an electricity company." The analyst points out that BT is a utility-type, low growth rate company, its business is heavily regulated and, apart from the CFO, the management team is poorly regarded in the city. "It's absolutely the right move for Moody's to make," he adds. But, according to a major UK investor, Moody's has put itself into a corner. "It isn't as if they are losing an Orange in spinning off BT Wireless," he says. "If BT does what they've promised, they will end up having to buy back bonds."
What is clear though is that the market had little clue about how to react to the step up. Initially, there was an upturn. "When BT was downgraded, the bonds should have widened by 25bp for the cash price to remain constant but the bonds actually showed the equivalent of a 10bp tightening. In other words, the market was saying that the kicker was more than sufficient to offset the impact of the downgrade," says Sarah Martin, European telecom analyst at Lehman Brothers. Then spreads widened again as some investors looked to take profits.
There was also a knock-on effect on other bonds that incorporate step-up language. These have increased over the past year in the telecom sector. Deutsche Telekom was the first in June 2000 when, to help its bond deal get off the ground, it said that if both agencies downgraded it to BBB, it would pay 50bp extra. Since then, the coupons have become more generous with BT and France Telecom both pledging 25bp extra per agency per notch and KPN 37bp per notch.
The problem is that investors aren't used to trading these bonds yet. "The market is still trying to figure out how to assign value to bonds with coupon step up language," says Anja King, head of telecom research at Deutsche Bank. Inefficiencies still exist in the market as can be seen from the fact that the KPN '05 without a coupon step up trade over 20bp inside the KPN '06 with language.
  Page 1 of 2  Next | Single Page






EBITDA: Earnings before I tricked the dumb auditor

Top 10 financial definitions that are funnier since the credit crunch

  1. US treasury market reaches breaking point

  2. Top 10 financial definitions that are funnier since the credit crunch

  3. Top 10 reasons to tell your boss you deserve a bonus this year

  4. Nomura’s great leap forward: Will Lehman takeover help fulfil its global ambitions?

  5. Eksportfinans turns to government for funding

Latest Issue

December 2008
Ruromoney Jobs Post a job

Home | Mobile site | Contact Us | Debt markets | Equities | Foreign exchange | Banking | Alternative Investments | Regions and Emerging markets | Polls & Awards | Structured credit | Back issues | Euromoney store | Useful links and Related events | Site Map

The material on this site is for financial institutions, professional investors and their professional advisers. It is for information only. Please read our Terms and Conditions, Privacy Policy before using the site.

All material subject to strictly enforced copyright laws. © 2008 Euromoney Institutional Investor PLC.