Debt markets: What’s behind the divide between the US and European corporate debt markets?

Many corporates are now trading well inside their respective sovereigns and some of their banks – a situation that would have been unthinkable until recently. "The risk transmission from sovereign to corporates was thought to be a classic pass-through mechanism," says Jamie Hamilton, institutional credit portfolio manager at M&G Investments in London.

Hamilton manages a range of segregated and pooled funds, including the M&G All Stocks corporate bond fund. "But there is a feeling that for certain areas the sovereign rating ceiling mechanism is broken," he says.

The problem, of course, is that most corporates don’t need any money. That hasn’t stopped them accessing the debt markets in their droves in the US. Their new safe-haven status has meant many US corporates have been able to fund at levels that have stunned even the most seasoned syndicate veterans.

Towards the end of August the US investment grade market printed 18 deals worth $20 billion in a single day – its busiest ever. Firms such as Walt Disney and Johnson & Johnson have tapped the market at record lows. And at the end of September, McDonalds issued $500 million of 10.25 year notes at a record low coupon of 2.625% through Citi, JPMorgan and RBS. And in July single-A rated industrial gas and equipment supplier Air Products and Chemicals issued $350 million in five-year notes at a coupon of 2% via Barclays Capital and Deutsche Bank, prompting one seasoned market observer to tell Euromoney: "Two percent for Air Products is just insane."

While the sheer weight of demand in the US for high-quality corporate paper continues to surprise, what does not is that at the same time as these deals were flying out of the door the corporate bond market in Europe was totally dead.

Not that any reinforcement was needed, but the performance of the bond markets on both sides of the Atlantic over the summer has only served to emphasize the depth and liquidity of one and the fickleness of the other. When BMW printed a €1 billion six-and-a-half-year issue in late July it was the first euro corporate issue for two weeks – and the last for a further seven.

It also underscored the different reaction of corporates in the US and Europe to the extraordinary funding environment they find themselves in. In the US firms are taking advantage of record low coupons in the bond markets; in Europe underwriters are grumbling that firms simply cannot see the opportunity that is in front of them.

The figures for euro-denominated corporate investment-grade volumes certainly make sobering reading. According to Dealogic, issuance stood at €76.1 billion year to date at the end of September, down 22% from 2010 and the lowest year-to-date volume since 2005.

Compare this with the US. As of September 20, in 2011 $155 billion in bonds had been issued in US dollars by US corporates with a rating of single A and above. Other than in 2009 such high volumes on a year-to-date comparison have not been seen this century. Last year up to September 2 only $88.7 billion was issued by those corporate borrowers.

"The Eurobond markets for investment grade corporates in Europe have been disappointing," says Anthony Bryson, head of corporate DCM, Europe at BNP Paribas. "Far too often we are still having new issue premium discussions with issuers as though we have orderly markets. BMW opened and shut the market in July but in the US market behaviour is a lot more rational. The investor base is more organized which is why we have seen an avalanche of oversubscription in the US and little in Europe until very recently."

Both the US and the eurozone have experienced prolonged sovereign debt crises and both have banking sectors beset with problems. Therefore the difference in investment-grade corporate behaviour must be attributable to market mentality, argue underwriters in Europe.

"The US dollar market is more consistently open – and this is exaggerated during times of crisis," says Dominic Kerr, head of European corporate origination at HSBC.

In the US, the decision to take advantage of cheap debt financing window is, at present, a simple one. Hewlett-Packard raised $4.6 billion in bonds in September when it already has $15 billion in cash on its balance sheet according to earnings reports in July.

Market conditions in the corporate investment-grade sector have made it one that simply cannot be passed by. Single-A and higher-rated US corporates are witnessing some of the cheapest funding environments they have ever seen. For example, the Merrill Lynch Investment Grade Index at the end of June 2007 was 6%; it is now 3.7%. The index tracks yields for all US investment-grade corporate bonds.

"The coupons on many issuers’ bonds being issued are the lowest that they have ever issued. It is certainly great right now to put five-, 10- and 20-year debt on the balance sheet," says Nigel Cree, head of debt syndicate for North America at Deutsche Bank in New York.

Pent up demand

So is the lack of issuance in Europe a result of issuer or investor intransigence?

There can be little doubt that there is substantial pent-up demand for euro-denominated corporate paper given the issuance drought over the summer. "The universe of countries that is being tested by the market is a moving target," says Tomas Lundquist, head of corporate DCM at Citi in London. "Even with spreads on financials at all time wides investors have no inclination to buy: they all want to buy corporates."

And they were frustrated in that aim throughout the summer by the issuance drought. "Investors have cash to put to work," says Huw Richards, head of high grade DCM for Western Europe at JPMorgan. "Issuance has been below average over the last few months, so investors have built up a lot of cash and there is a willingness to invest."