Heyday of the capital markets

Remember how the internet was going to put securities firms out of business? It isn’t happening yet. Never before have investment banks made so much money from international capital markets. Volumes are rising across all categories. Underwriting fees are holding steady. And lucrative areas such as capital instruments, leveraged finance and securitization are bursting into life. Meanwhile, the equity markets have been a thrill-a-minute roller-coaster ride. But times aren’t as good for issuers and investors. As prices slide, bond and equity buyers alike have lost money. And issuers have had to jump through hoops to complete deals in crowded and volatile markets. Michael Peterson reports

Fees only go in one direction - down. Bankers throughout the capital markets use the same phrase to bemoan the lack of money in their business. Maybe so. But they complain with less conviction than they have done in the past.
Fees on bond issues from frequent borrowers have never been generous and they are still under pressure. For frequent borrowers of all types, such as supranationals, agencies and Pfandbrief issuers, there is a continuing trend towards large, liquid deals which leave only thin margins for underwriters. These borrowers have also been the quickest to embrace electronic distribution and are keen to get their bonds listed on government bond trading platforms such as EuroMTS.
But bond volumes are increasing dramatically and most of the growth is not coming from these cost-conscious borrowers. Last year a record $1.4 trillion-worth of international bonds were raised. This year, in spite of a few quiet moments, is on course to be even better. "These are rates of growth one presumably associates with a new hi-tech market, not with something supposedly as mundane as Eurobonds," notes John Winter, head of debt capital markets at Deutsche Bank in London.
The big transformation in the bond markets has been the appearance of jumbo corporate bonds. These are prestigious mandates which underwriters Fight hard to win, but they are not by any means low-margin business. Sure, Unilever paid fees of only Five basis points on its $7.4 billion equivalent issue in August, but that short-dated Floating rate note is not typical of the pattern of corporate issuance in the past 12 months.
The headline-grabbing deals of 1999 and 2000 have been different to the jumbo deals of the past. This isn't the First time we have seen big deals in the market, says Charles Berman, head of European debt capital markets at Schroder Salomon Smith Barney. But in the past the big borrowers were supranationals, sovereigns and agencies looking to raise funding at a certain hurdle rate. Never before have we seen corporates mobilizing capital for strategic events in such large volumes.
Frequent names suffer
The Flood of corporate bonds is not necessarily good news for regular users of the international bond market. These frequent borrowers have been hammered on two fronts over recent months. First, heavy corporate supply is pushing out spreads for all borrowers. "For those issuers with Libor funding targets life has become more difficult this year," says John Fleming, head of European debt syndicate at Credit Suisse First Boston in London. "A frequent issuer which traditionally funded itself at 10 basis points below Libor might now have to pay Libor plus."

Second, since the beginning of last year European investors have been dumping highly-rated bonds in order to buy higher-yielding credit products and equity. "As European investors have switched from buying triple-A bonds into credit, the issuers who have suffered most have been European frequent borrowers," says Paul Hearn, head of European debt capital markets at JP Morgan in London. "The US agencies, which historically traded worse than European triple-A borrowers, have started to trade significantly better than Europeans such as KfW and the EIB. This is clear evidence that the strategy the US agencies began to adopt a couple of years ago of issuing from big programmes is working."
For the two biggest US agencies, Fannie Mae and Freddie Mac, the name of the game has been liquidity. They have been striving to turn their bonds into surrogates for ever scarcer government debt by doing regular and very large bond issues. No European non-government issuer has borrowing requirements on the scale of Fannie and Freddie. Borrowers such as KfW and the EIB have suffered from offering neither the liquidity of the US agencies nor the yield of corporate issuers.
Some bankers complain that the traditional skills of the Eurobond market - spotting opportunities for arbitrage and hunting out pockets of demand - are being undervalued. In their haste to do big strategic deals, some corporates, they say, are paying over the odds.
But others maintain that corporates are no less demanding than old-style Euromarket issuers. "Pricing is often just as important to corporate borrowers as it is to traditional arbitrage-driven issuers," says Winter at Deutsche. "Being able to raise cheaper funding than its peers gives a corporate a real competitive advantage. A significant difference compared to an arbitrage-driven borrower, however, is that an attractive price is not necessarily determined just by the deal's spread to Libor. A corporate is likely to be raising funding for acquisitions or expansion rather than lending it on to someone else, so the absolute level of interest rates or currencies may also be very significant." If interest rates continue to move upwards, the primary markets may suffer. But that's a worry bankers can put off for another day.
Year of the telco
Deutsche Telekom's $14.6 billion equivalent offering in June was by far the biggest corporate bond in the First half of 2000 - in fact, it was the biggest bond issue ever. But WorldCom, Vodafone, KPN and France Telecom have all raised the equivalent of more than $4 billion in individual offerings.
What all these companies have in common, of course, is that they are large telecom companies. This industry has dominated the entire debt markets this year. There was more international bond issuance by telecom companies in the First half of 2000 than in the whole of 1999. If volumes are as high in the second half of 2000 as in the First six months - and many believe they might be higher - telecom bond volumes will have nearly trebled compared to the $49 billion that was issued in 1998.
In the loan market too, big telcos are consuming liquidity at a rate never seen before. Telecom companies received more than 21% of all syndicated lending in the First half of 2000, compared to just over 14% in 1999. Borrowing on this scale is fantastic news for those investment banks which can extend large bridge loans at short notice. It also favours those Firms with special expertise in telecoms - notably Schroder Salomon Smith Barney, which has dominated the telecom bond league tables this year.
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