Fannie Mae goes sterling
"Three deals on the screens this morning an exceptional quantity!" exclaims the global origination manager at a Dutch investment bank. Eurosterling issues have already delivered £8.5 billion this year. Following a record 1996, when total issuance was £34.6 billion, Eurosterling looks set to surpass gilt (UK government bond) issuance in 1997.
The recent growth in the number of Eurosterling deals is matched by increased investor sophistication. On February 12, Fannie Mae (the Federal National Mortgage Association) issued the very first global sterling issue. Worth £1 billion, it is the largest ever single-tranche transaction. A market for corporate debt has also developed this year. Of the 55 issues so far in 1997, 20% have been corporate paper an unusually high proportion. According to Frank Kennedy, executive director responsible for UK debt capital markets at SBC Warburg, this is "the most notable feature of Eurosterling".
Eleven corporates have already done Eurosterling issues this year, compared with a total of 18 in 1996. Traditionally, Eurosterling has been dominated by a few frequent borrowers, usually sovereign or financial institutions. Corporate paper has been rare and issued as much for prestige as for financing. Now the market is developing along the lines of the US domestic bond market, which has a strong corporate sector offering a regular selection of new issues with a wide range of credit quality.
Corporate names are appearing in both short and long maturities. In the three-year to five-year bracket, they are attractive to retail investors because of their rarity. Maturities of 10 years and over are preferred by UK institutions looking to pick up yield over gilts and supply UK Pep (personal equity plan) fund demand. In all maturities, an increased demand from overseas, particularly Asia, continues to strengthen the markets.
As economic and monetary union (Emu) approaches, sterling has developed safe-haven status. The UK's relatively healthy economy compared with those of core Europe provides attractive interest rate differentials for the investor. "In order to understand the degree of market interest in sterling, you have to go back to the dramatic fall in September 1992 when sterling was effectively forced out of the exchange rate mechanism," says Matthew Merrit, senior global strategist at ING Baring Securities. "Just five years on, there has been a reassessment of sterling to the extent that it is back at the lower end of the previous exchange rate bands."
The return of retail
The strength of sterling against the Deutschmark and Swiss franc has made it once again an attractive option for Eurobond retail investors in Germany and Switzerland and their fund managers. These investors have been out of the Eurosterling bond market for some time. Their investment in Eurosterling issues with three- to five-year maturities is a driving force behind sterling's success in 1997.
"It will take a while for them to fill their portfolios," says the Dutch investment banker. "Sterling should stay in favour for some time." Since the start of this year Eurobond retail investors have begun to invest more in rarer corporate issues and big consumer-product names. This is a selective response to the frequency of issues by financial institutions which, according to the manager at the Dutch bank, "are beginning to exploit the arbitrage".
UK bank Abbey National is one institution that has suffered from this shift in interest. Since 1995, it has made 14 Eurosterling issues, worth a total £2.2 billion. Despite good credit rating (Aa2 from Moody's Investors Service; AA from Standard & Poor's), Abbey National paper has not always been well received.
According to a source at the bank, it has "certainly made some mistakes" in the targeting and structure of Eurosterling issues. In order to attract investors in 1997, Abbey is continuing its vigorous regime of roadshows. It has also tried to entice investors with extra yield on a callable structured three-year issue.
"The structured deal was investor-driven and sold out," claims Abbey National treasurer Alex Brown. Kevin Lorkin, fund manager at UK insurer General Accident, is less impressed by structured issues. "It won't help to make complicated structures like the Abbey issue with an early call and extra yield," he says. "The investors will see it's just the same issuer raising sterling by another means. Issuers will have to pay extra or go to another market."
Investor preference for rare corporate paper may therefore have been caused by overkill on the part of financial institutions. "[They] issue in a continuous fashion, not always because they need the money but to take the cash and put it on their books," Lorkin says. "Corporates are less frequent issuers, borrowing only when they really want to."
Brown contests this view: "People love corporate paper simply because the banks account for a large proportion of the issuance." It's been that way for years, he says, "but there is a limited supply of corporate paper about. As in the case of our structured issue, it's the banks [the investors] approach when their targets can be met."
Of the £2.4 billion of three-year maturity issues since January, 30% has been from private corporate issuers with strong credit names. Siemens Capital Corp, GMAC International Finance and General Electric Capital Corp were all received as attractive issues by Eurobond retail investors and fund managers.
On January 21, Swiss food manufacturer Nestlé issued £100 million of three-year, fixed-rate sterling bonds. The issue sold within minutes of the launch, at seven basis points over the 6% 1996 gilt. Vehicle maker Daimler-Benz UK was similarly successful with its £100 million of sterling bonds, also issued in January. "The demand for sterling was high and favoured strong corporate names," explains Erkhard Zangar, financial communications manager at Daimler-Benz.
Issues by Daimler, Nestlé, Harvard University and US carrier United Parcel Service have not shown good liquidity. Three-year retail targeted issues are usually small and sit in portfolios until redemption. Traditionally, investors in Eurosterling bonds have fallen into two clear groups: retail investors stick with the three-years and institutions invest in issues with maturities of five years and over. The illiquidity of recent corporate, retail-driven issues has reinforced that division.