Is this as good as it ever gets in the international debt capital markets?
There’s continuing and large-scale central bank quantitative easing; new economic data soft enough to suggest continued accommodation, but not disastrous enough to herald economic catastrophe; reduced new-issue volume from a deleveraging banking system creating a scarcity of paper; and investors desperately searching for yield. These have all combined to create near-perfect conditions for a wide range of borrowers.
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Bond deals from risky issuers such as peripheral European sovereigns, peripheral and emerging market corporates and banks, and from high-yield borrowers that might not have been able to access the markets at all a year ago, are regularly being heavily over-subscribed. And this exuberant investor demand comes even when borrowers offer pricing that tests new lows every day for absolute yields and spreads to risk-free benchmarks. For the leading debt capital markets banks, this has been good news. With one important client group – namely banks – issuing far less debt, global DCM volumes were down by 14% overall in the first quarter of this year compared with the first quarter of 2012, according to Dealogic. But the leading investment banks’ DCM revenues were up marginally because riskier borrowers, across investment-grade corporates, high-yield and leveraged finance issuers and emerging market names, have together taken up the slack.
That momentum picked up in the second quarter. Peripheral sovereigns such as Portugal and Ireland returned to the debt capital markets, not just with taps of short-dated deals, but also with new 10-year benchmarks. Spain and Italy have borrowed with ease, and banks and corporates from the periphery have followed their sovereigns. Emerging market issuers have had a field day, such that by May 15 Dealogic reported that international emerging market DCM volume had increased to $251 billion in 2013, the highest mark on record. That’s up by 27% on the $198 billion raised over the same period in 2012, which was itself a banner year.
From the start of 2013 to mid-May, banks’ DCM revenues were running 12% ahead of the same period in 2012 and had hit record year-to-date levels of over $9 billion.
When market participants see corporate bonds such as Apple and Petrobras with $50 billion order books, the first thought in the minds of most of them is that surely this cannot last.
It may have a while to run yet. Economists at Barclays have looked at the new supply of various types of double-A and higher-rated debt, including government bonds, corporates, covered bonds and asset backed, likely to be issued this year and put the total at $2.03 trillion. Against that, they see likely central bank buying of $1.95 trillion.
There’s not a lot left for anyone else.
“It really brings home the influence central banks are having on the debt capital markets when you see the sheer amount they’re set to buy before institutional investors even get a look in,” says Mark Lewellen, head of DCM Emea at Barclays. “These drivers are why you see a diverse range of issuers like Diageo achieving record low coupons and why an emerging market issuer like KazMuniGas is able to successfully raise $2 billion of 30-year debt at 5¾%. With this backdrop, we don’t expect these exceptionally strong new issue markets to abate any time soon.”
Even while Federal Reserve chairman Ben Bernanke tries to let some air out by warning about the asset bubbles the central banks are themselves creating, investors have to chose: buy at these levels, or sit tight and risk your competitors outperforming you.
Danielle Sindzingre, head of fixed income and currencies at Société Générale, says: “While our own house call is that 10-year US treasury yields could be up to 2.75% by the end of this year or even higher, our investor clients are very much focused on the here and now. They are very tactical and they’re not fighting the trend. Liquidity is the main driver of performance. The hunt for yield and the compression trades are still on: extending duration, taking extra credit risk, moving out of the top names even among sovereigns, supranationals and agencies.
“So we talked to investors who wouldn’t touch the periphery back in 2011 at over 6%, but are now going in, even after the recent rally, at under 4%. There’s still a sense that soft economic data are good for all asset classes, that yields will go down, and that’s why investor demand for corporate new issues is so strong.”
The gloomy economic outlook in Europe weighs on corporates’ requirement to raise funds. But new-issue volume from corporates had held up better than many DCM bankers feared at the start of the year. Although few companies are borrowing for capital expenditure or to acquire competitors, they are still borrowing for the oldest reason of all: because debt is cheap.
“Is it a bubble?” asks Demetrio Salorio, head of debt capital markets at Société Générale, anticipating Euromoney’s inevitable question. “Certainly there is a lot of cash that needs to go to work, and you see very large order books for many transactions. But if you’re three times oversubscribed and then try to cut 10 basis points off your spread, you can lose most of that demand. Investors are actually being quite disciplined on price. And remember default rates are very low. We don’t see non-specialist investment-grade funds chasing into high-yield markets, for example, and that’s healthy.”
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| Melissa Smith, head of high-grade DCM Emea at JPMorgan |
Melissa Smith, head of high-grade DCM Emea at JPMorgan, says: “These are among the best conditions for new issuance we’ve seen in a long time, even after strong recent spread performance and amid signs of US investor caution over the absolute rate environment. It’s worth noting though that even as the search for yield continues, what we’ve seen most recently is particularly strong demand for transactions from higher quality names, such as Nestlé, LVMH, Apple, Microsoft and Bosch, that are infrequent rare issuers. We have also seen increasing investor demand for short-dated floating rate notes given concern over rising rates. “On the supply side, issuance is being driven by opportunistic borrowers who are prefunding upcoming maturities of higher coupon bonds and even bank debt while also extending the duration of their liabilities at low yields and spreads.”
And although some analysts continue to believe that another blow-up in Europe will come soon enough and that the market conditions that have allowed peripheral sovereign borrowers and other risky issuers to return in size are artificial, investors still have to play these technical factors as much as the economic and credit fundamentals.
“Looking at relative and absolute yields, peripheral SSAs do still look attractive on a risk-reward basis when compared with many other asset classes,” says Bryan Pascoe, global head of DCM at HSBC. “While there will be bumps on the way through the medium-term cycle, there is some room for further out-performance.” But he suggests borrowers should not imagine such benign conditions will last forever, and even now, they should take care while they do. “We advise clients not to be too frequent if their borrowing programmes permit and to do fewer but larger on-the-run deals targeted at the deeper liquidity pools. Dancing carefully around key economic data points and events is also a key element to success, although less of a concern than in 2012.”
It’s a fine argument whether investors truly are being discriminating or just betting on the Draghi, Bernanke and Bank of Japan puts. Certainly they see the primary markets as the best place to put large volumes of money to work and are placing some very big orders. One banker says: “We’re used to order inflation from some US investors, especially those looking to flip, but we did a €500 million deal this morning and had one normally conservative European investor try to place an order for half of it. In the past, investors operated informal limits of never wanting more than 10% of any deal.”
Even if the rate cycle or the credit cycle turns are still one-and-a-half to two years away – as they seem to have been pretty much continuously for the past 18 months to two years, according to investment bankers – turn they eventually must. What happens then?
Jonathan Brown, head of bond syndicate Europe at Barclays, says: “At present investors are finding the buyside liquidity from the primary markets, and the secondary market is not regularly tested. As market conditions turn, recent changes in regulation will focus the mind on whether there is sufficient liquidity for investors to move the inventory they might want to liquidate. Changes in risk weighting calculations with Basle III and Dodd-Frank have changed the dynamic for secondary market liquidity in a meaningful way.”
Perhaps responding to concerns from their end investors, a number of SSA borrowers are taking demonstrated commitment to provision of secondary market liquidity into greater account when granting primary market mandates. So too, increasingly, are some of the more frequent corporate and financial borrowers, according to DCM bankers.
“Although we have not asked for formal commitments from our banks on provision of liquidity, partly because our benchmark deals are large and inherently liquid and our spread volatility is limited by virtue of reference to several points – mid swaps, French government bonds, EIB – we constantly monitor the activity of our banks in the secondary market and take investor feedback on this,” says Christophe Frankel, chief financial officer and deputy chief executive of the European Financial Stability Facility.
Euromoney surveys the biggest borrowers in the debt capital markets each year – this year’s survey received replies from more than 200 of them, including half of the top-50 corporate issuers in the international debt capital markets – and asks which banks are doing the best job for them.
It is noticeable this year that HSBC has jumped to the top of that overall ranking from third in 2012, while JPMorgan has climbed up from fifth position in 2012 to second. These two banks have thus pulled ahead of Barclays, which was first in 2012 and falls to third this year, and Deutsche Bank (second in 2012 but now fourth in the latest survey).
All the top banks are good at deal execution and issuer coverage. That’s a given. It seems there is a direct correlation between the rise of HSBC and JPMorgan to the top rank among borrowers’ favourite banks in the primary market this year and their rise in the ranking for commitment to secondary market support.
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| Bryan Pascoe, global head of DCM at HSBC |
Pascoe at HSBC says: “Trading capacity across the street has been cut dramatically in response to regulatory and shareholder pressures, but most of the hard work on this now seems to have been done. Alignment with primary and broader institutional relationships are now much more the drivers of activity in the secondary credit space, and most banks now have much more focused trading businesses than, say, two or three years ago.” Even here, Pascoe adds a qualifier. “Institutions will be much more inclined to provide liquidity to investors who they feel they have a strategic relationship with. This is just another example of how banks are using capital in a much more targeted manner than before.” Smith at JPMorgan says: “There has been a lot of noise around lack of secondary market liquidity and dealer support, but when you look at the US market data it suggests that the key difference today compared with prior years is that liquidity is still there but that it is increasingly concentrated in certain on-the-run bonds. “As a firm, we have always offered secondary liquidity support on our deals and we are still doing this – we see it as a competitive advantage. If anything, we would be happy if investors were even more vocal in letting issuers know how important that is.”
Agence France Trésor publishes findings on its lead banks’ performance in the secondary market from its own surveys of investors; in December 2012 it found that investors were more satisfied with liquidity in French government bonds than they had been in 2011. “When I talk to investors they tell me one of the important reasons they are happy to buy French debt is the very tight bid-offer spread in the secondary market,” says Ambroise Fayolle, chief executive of AFT. “That is down to the work of our primary dealers, and we thank them for that.”
It’s probably not a coincidence that the dealers work so hard, knowing AFT will publish the results of its review of their performance with investors and rank them accordingly. The Italian Treasury allows a noncompetitive tap of up to 5% of its auctions as a reward to its top-performing primary dealer banks. That’s a nice incentive, as long as investors want to buy bonds.
Right now, several banks are trying to make a mark with borrowers by being aggressive on price in the secondary market and turning over large volumes. Goldman Sachs, for example, is making a big play once again in the debt markets.
The true test of commitment to secondary liquidity will come only when the debt markets turn. That’s not meant to be for another 18 months to two years of course… but it could be sooner.
