Europe's new currency might have had a stinking debut on the foreign exchange markets, falling by nearly 10% against the dollar in the first two months, but participants in the Eurobond market couldn't care less. For Eurobond market firms, life has rarely been sweeter. The launch of the euro has brought in its wake a bull market: a boom in new issues and an opening up of the market both to new borrowers and new investors.
In the first two months of this year, the euro rose to prominence, accounting for 49% of international market new issues, compared with 41% for the Emu 11 currencies during 1998. Meanwhile dollar deals accounted for 35% of new issues in the first two months, compared with 38% in 1998. There were some €15 billion of corporate deals in the first two months of 1999, compared with under €4 billion in the same period in 1998. And deals are getting larger. Almost 23% of new issues in the first two months were for amounts of €2billion equivalent or more, compared with 7% in 1997. "Dm1 billion [$550 million] deals used to be considered large. Now €1 billion deals are run of the mill. It just has the feeling of being a bigger, more developed market," says Guillaume Bonpun, head of fixed income syndication at Dresdner Kleinwort Benson, summing up a confident mood.
Confronted by record low yields on government bonds, European investors have been buying corporate bonds with unprecedented enthusiasm. Not only are deals bigger than ever before, they are generally selling well and showing decent aftermarket performance. Many issues have been priced inside initial price-talk and then increased in size. Market practice for new issues is evolving away from hard underwriting towards the sort of techniques used in the primary equity market, such as book-building and price-discovery. That makes deals less risky for arrangers. Even more enticing: in a new issue market that now breaks down broadly into a dollar bloc and a euro bloc, the leading positions in the arranger bulge bracket are, for the first time following more than half a decade of domination by US firms, up for grabs.
Some of this excitement may ultimately prove short-lived. Following the emerging-market and Long-Term Credit Management crisis last year, spreads on credit bonds widened far beyond fair value. It has been easy to sell credit bonds so far this year, when spreads have had so much room to tighten and European institutional investors have been pouring into the market new cash, flowing from government bond redemptions and interest payments. Spreads on single A rated corporate Eurobonds were around 35 basis points last June. They rose to around 60bp last October and were back to 40bp by this February. Spreads for double A rated financial issuers were also around 35bp last June, peaked at 95bp in October and had come in to under 60bp this February.
And there has been precious little competition for corporate issuers so far this year from that other traditional source of credit spread: emerging markets. "Russia broke the taboo on defaulting: something we haven't seen for many years," says Cyrus Ardalan, global head of fixed income marketing at Paribas, "and that has had an important psychological impact. For essentially emerged countries, the markets are receptive. Hungary is trading at 87bp which is 10bp tighter than we thought investors would accept. But many other emerging-market countries are simply beyond the pale. Ukraine, to take an extreme is above 5,000bp over." The toughest deals this year have been emerging-market issues: BBB- rated Colombia abandoned its attempts to sell a deal of between €400 million and €500 million after failing to attract much demand on price talk of a 675bp spread; BB+ rated Philippines cut its hoped for €500 million 10-year deal to a €350 million five-year deal, and having hoped to price at a spread of under 400bp, eventually paid 425bp. Croatia did a little better, increasing a €250 million five-year deal to eventually launch a €300 seven-year deal at 375bp over Bunds. But the borrower nearly overreached itself. Market sources say lead manager Credit Suisse First Boston had to hold a large portion of the deal and when it eventually sold, the spread widened. Turkey provided a rare bright spot with a Dm750 million four-year deal at 630bp over Bunds sold to German retail and increased from Dm500 million.
European investors have turned away from emerging-market sovereigns in their search for yield towards single A corporates. "Certain Dutch funds which one year ago wouldn't touch anything but government paper, will now go as low as triple B," says Andrew Pisker, global head of bonds at Paribas. "But it has to be for something that is analyzable for them and that offers transparent accounting, clear bankruptcy laws and no convertibility risk." For corporate borrowers this has opened up a world of possibilities. "Deals are getting done for borrowers that couldn't access this market last year and certainly not in large size," says Simon Meadows, managing director at CSFB. He mentions a €300 million 10-year deal for Principal Financial, the fourth-largest US insurer, but a little known credit in Europe, which CSFB brought to market in January. "We sold one-third of that deal to French investors. There is no way that could have been done two months earlier."
By mid-March, the first signs were appearing that demand for such corporate bonds, which easily outstripped supply in January and February, was beginning to be satisfied. Spreads on keynote deals: a €500 million 10-year deal from Telefónica de España and a €1 billion five-year issue from Fiat, both widened after launch. So what happens when all the new cash has been put to work and credit spreads have returned to normal levels? Is it possible to detect amid the short-term exuberance what are the significant long-term structural changes in the Eurobond market? And what are the key ingredients for arrangers to succeed in this fast-changing environment?