The primary debt capital markets threatened to seize up, as the European fixed-income markets suffered renewed volatility in May amid growing fears of the possible severe contagion effects on sovereign and bank bonds from a Greek exit from the euro.
On May 9, one of the busiest corporate issuers, German auto-maker Volkswagen, which has completed several deals in niche currencies and the larger bond markets in 2012, prepared to test the market with a five-year euro-denominated benchmark offering. Market participants braced themselves to see if the investor community would support a €1 billion deal amid such widespread risk aversion, as the underwriters offered price guidance of 65 to 70 basis points over mid-swaps.
They need not have worried. The deal generated a €3.3 billion order book from high-quality accounts attracted by a yield of just 2% for the single-A- rated issuer. Volkswagen felt able to increase the size of the deal to €1.5 billion even while offering only a modest new-issue premium of just 9bp over its interpolated secondary curve, after pricing at the tight end of the range.
“We are particularly happy with the outcome of this transaction as it came on a very volatile day,” Kai Otto, head of capital markets and asset management at Volkswagen AG, tells Euromoney. The company aims to issue benchmark bonds regularly but not so frequently as to tap out demand in the core dollar, euro and sterling funding markets. It has also borrowed this year in Japanese yen, Norwegian kroner, Australian and Canadian dollars, as well as through ABS. In March Volkswagen launched a series of US dollar deals totalling $3.35 billion, across two-, three- and five-year maturities and last sold a big euro benchmark at the start of the year. “We feel that transparency and consistency in our communication with market participants pays off in times like these,” says Otto.
The ability of a single-A-rated corporate frequent issuer to raise debt funding when supposedly better-rated banks and sovereigns are struggling to do so denotes a fundamental shift in the debt capital markets. Otto says: “We felt we always had very good access to the debt capital markets. However, in terms of costs we have definitely seen a very strong improvement for corporate issuers recently.”
That improvement was evident at the start of 2012, even before the temporary beneficial effects of the European Central Bank’s long-term refinancing operation (LTRO) came to be felt on bank and sovereign funding. On the third business day of the year, single A-rated BMW attracted €7 billion of demand for a €2.5 billion two-tranche deal. This strong demand for corporate debt, when investors see many corporates sitting on strong balance sheets with decent earnings and often large stockpiles of cash, making them much more attractive than financial issuers or sovereigns, is clearly evident beyond the European markets. SABMiller’s $7 billion bond in January was the largest corporate yankee bond for three years, and BHP Billiton’s $5.3 billion issue is the largest deal from an Australian corporate on record.
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| Nicolas Bamber, head of investment-grade debt origination at RBS |
In Europe, an important shift seems to be afoot. Dealogic, running investment-grade corporate new-issue volumes for the year to May 11, shows $182 billion raised from 315 deals over this period in 2012, up from $118 billion last year from 259 deals and $126 billion from 253 deals over the same period in 2010. “Given the choice between sovereigns, financials and corporates, bond investors are choosing to invest in corporates,” says Nicolas Bamber, head of investment-grade debt origination at RBS. “When corporate bonds are trading through the levels of government bonds, that’s a pretty clear statement of investor preference. Until we see overall confidence return to financial markets, corporate debt will remain the asset class of choice.” Some corporate issuers, still scarred by the near closure of financial markets during the depth of the banking system crisis of 2008 and 2009, have opportunistically accelerated their funding in the first months of 2012 to take advantage of the overwhelming demand for corporate debt amid the temporary calm of the first quarter. A source at Daimler tells Euromoney: “We’ve issued €6.9 billion of bonds this year as the market environment was very favourable for corporate issuers like ours. We think we got the timing right. You will see us less frequently in the market in the next eight months since we have already refinanced much of our needs. Maybe we’ll sell about 50% of the volume we’ve issued so far this year for the rest of 2012.”
Groupe Casino, the triple-B rated French supermarket operator that is now expanding in Latin America and Asia, is a regular issuer by the standards of the retail sector. It brings two deals a year, its most recent being a well-subscribed €600 million eight-year bond in March. The company had had a taste of strong demand for its debt in February when it paid off a maturing bond and received reverse enquiries from insurance companies hoping to restore their exposure through private placements, a market it has not accessed in euros.
“The coupon on the March deal was the lowest ever for Casino and we find that in good times we can issue longer maturities,” says Amandine Lezy, head of financing. The long maturity on its latest bond helped the company extend the average maturity of its debts from 4.2 to 4.6 years. The deal finances the company well ahead of forthcoming maturities. “We are conservative and like to fund at least a year and sometimes even further ahead of maturities to protect ourselves against the markets being closed,” says Guillaume Humbert, head of corporate finance. “The bond market is a market of windows. We’ve seen periods when we could probably only get more expensive money for shorter tenors and we saw the market close down completely last summer for three months. So, given constraints around our own earnings releases as well as periods when there are blue skies in the bond market, we have to be prepared to issue at short notice.”
However the reception for the Volkswagen deal amid all the uncertainty around Greece and Spain suggests that good-quality corporate issuers, certainly those based in northern Europe, might enjoy continued market access even as anxiety spreads over possible widespread bank runs and capital controls in Europe.
Philippe Bradshaw, head of investment-grade corporate syndicate for Europe at RBS, suggests that the underlying investor base in Europe is changing in ways that might last beyond any short-term paroxysms. “Fund managers are collecting mandates, often from smaller investor clients, to manage pools of assets that concentrate almost solely on corporates and exclude issuance from banks on the basis that very few credit analysts can understand banks’ balance sheets and financials anymore. An investor community that paid relatively modest attention to corporates up until 2008 [back then in the year to May 11, European investment-grade corporate DCM amounted to just $89 billion] now sees corporates as the safe haven.” He adds: “We expect corporate bonds to be well bid for a long while to come, so corporates don’t even need to rush to issue, just because demand is there.”
Marco Baldini, head of European corporate syndicate at Barclays, points out: “There used to be corporate credits on one side of the bond market and so-called risk-free assets from sovereigns and supras on the other. Now that’s changing, even for corporates domiciled in the European periphery but whose earnings and assets are not dominated by their home market. So you see so-called national champion companies, like Enel in Italy or Iberdrola in Spain, trading inside their respective sovereigns.”
And while corporate issuers enjoy the benefit of this safe-haven status, some of those with large annual funding requirements, such as the auto companies that seek to provide funding to customers from companies leasing fleets of cars, right down to dealers extending loan finance to the buyer coming through the showroom door, are adopting some of the tactics of the old supranational frequent issuers: funding programmes ready to issue benchmarks in the major currencies; MTN dealers looking for low-cost funding in niche currencies and fielding reverse enquiry for quasi-private placements.
| European corporate IG DCM v corporate IG syndicated loans volumes |
| 2005 to 2012 YTD |
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| Source: Dealogic |
Corporates are taking whatever steps they can to extend the range of bond market buyers that can invest in their debt as banks cut their lending. So, for example, at the most basic level Heineken, the household-name Dutch brewer that has long accessed the euro debt capital markets on an unrated basis, went to the trouble of getting Baa1/BBB+ ratings affirmed by Moody’s and S&P in March. Just days later it came out with €850 million seven-year and €500 million 12-year bond issues. These were its first public bond deals since 2009 and, with many of those investors previously prevented from taking large exposure to an unrated credit now able to buy Heineken debt, the final book drew in €13 billion of demand from 750 accounts across both tranches. In the days after its ratings were announced, Heineken’s outstanding bonds had rallied by over 50bp, allowing it to capture an immediate financial gain from a lower cost of funding on the new issues.
Heineken quickly followed this up by mandating Citigroup to lead its inaugural dollar bond, a $750 million 144a issue. This highlights a second growing trend among its larger corporate brethren in Europe: to establish funding programmes in dollars as well as euros, rather like the frequent issuers of old. So, for example, Volkswagen, Daimler and Renault all now have dollar funding programmes.
This addresses a concern for European corporate issuers that arose amid the market closure that followed Lehman Brothers’ bankruptcy. Back then, it was the US dollar debt capital market that reopened first, initially for better-rated companies, then for those down towards triple-B, before the euro market reopened. In the first months of 2012, as corporates filled their boots with funding, it seemed that those issuers with established dollar and euro funding access could benefit from demonstrating their access to other markets by increasing investor competition for their paper. Demonstration of unchallenged and widespread access to funding from various sources might also send a strongly positive signal to shareholders.
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| Norbert Mayer, senior vice-president, finance, and group treasurer of BMW |
At the start of May, that concern about potential closure of the European debt capital markets returned. Norbert Mayer, senior vice-president, finance, and group treasurer of BMW, tells Euromoney: “Thankfully, when we planned our 2012 funding programme at the end of 2011, we did so amid some nervousness over the overall financial market situation. While that concern about the euro debt crisis diminished in the first quarter, it has returned in recent weeks. This takes me back to 2008 and 2009, when we faced the huge challenge of paralysed financial markets. We responded by restructuring our funding to derive it from a wider variety of sources and instruments and make it more robust and resilient to fluctuations in individual markets so that we can always make finance available to customers even if one market is seriously challenged.” So BMW didn’t rest on its laurels at the start of the year when it sold heavily oversubscribed three- and seven-year euro benchmark bonds. It followed this up with the largest-ever automotive corporate bond in sterling, a £750 million ($1.18 billion) seven-year deal that attracted some £2.5 billion of demand. “It is an important market for us for longer maturities,” says Mayer. “We were very pleased with the investor distribution. We could have raised more but decided not to due to the limit of our actual funding need.”
Unlike other European auto companies, BMW has not jumped through all the documentation hoops required to be a regular issuer of 144a dollar bonds in the US market. “It’s on our screen,” says Mayer. “But for now, given the very liquid euro market and our strong cashflows, our funding needs do not require an unsecured dollar public market presence. However in April we did a $780 million ABS. We have traditionally used the primary dollar market for ABS and were even able to do so in 2009 when the securitization markets had their challenges.”
To complement its large, liquid and longer-maturity benchmark bonds in euros and sterling and its US dollar ABS deals, BMW is also an opportunistic issuer off its MTN programme of typically smaller and shorter-dated deals in currencies such as Norwegian krone, Japanese yen, and Canadian and Australian dollars. Mayer says: “This programme allows us to customize some offerings for investors and is open to reverse enquiry as well as our own efforts to match maturities against a portfolio of largely short-term, under-two-year assets.” Although it issues reasonable volumes off its MTN programme, it does not employ the classic tactics of the supranational frequent issuers by doing heavily structured trades with substantial embedded optionality. Rather, it does only plain-vanilla deals.
Volkswagen takes a similar approach to funding off its MTN programme, according to Otto, who says: “We usually have no structures in our bonds.”
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| Tomas Lundquist, head of European corporate DCM at Citi |
This is the way many bankers see the private placement market developing in future as corporates pick up the volume that was once dominated by banks and supranationals. Tomas Lundquist, head of European corporate DCM at Citi, says: “Given the Moody’s downgrades of banks, many of them will carry lower ratings than the leading corporates, which in turn will attract more interest from private placement investors. In the past, supranationals in particular used to embed structures in their private placements but corporates won’t do that to the same extent. They tend to prefer plain-vanilla deals. Corporates want comparative simplicity in their capital structure and they don’t want to introduce the kind of volatility into their P&L that can sometimes arise as a result of the accounting treatment of embedded options. And from the buy-side perspective, investors were happy to buy more structured transactions from supposedly risk-free supranationals. But they are clearly taking credit risk with corporates even if investors see corporates as much more stable than financials. Investors generally don’t want to combine credit and structure risk, although there are exceptions.” There is another factor driving corporates to issue plain-vanilla liabilities: a wish to reduce their exposure to a troubled banking sector from counterparty credit exposure through derivatives. “It is better to hedge naturally than to have to pay for it,” says Humbert at Groupe Casino. The company funded its acquisition last year of the Thai operations of Carrefour in Thai baht. “There was a liquid funding market in baht and costs were competitive. Had local funding costs been higher, as in Vietnam, for example, we might have taken a different approach.”
The company is in the process of taking majority control of its Brazilian subsidiary. “When that process is completed, it will give us more exposure to emerging markets and to the Americas. So while we have not been active in the dollar bond market yet, there is a good chance that we will issue in dollars in the years ahead.”
Corporates are increasingly keen to match-fund against assets where they can and many are investing in establishing a presence in the renminbi bond market for precisely this reason, as they have assets in China. Otto at Volkswagen says: “We use derivatives to completely hedge any currency and interest rate risks related to bond issuances. However, one goal of our diversification in funding instruments is also to reduce derivatives by issuing in the market and currency where the funds will be used.”
Corporate issuers are increasingly mindful of their exposure to bank risk and are imposing counterparty limits to manage it. Mayer at BMW says: “We are dependent on bank partners in derivatives and assess very carefully the counterparty risks. We have in place a very strict system of counterparty limits and we monitor this very closely to make sure utilization does not creep up towards those limits.”
BMW is also concerned to shift its funding mix heavily towards the capital markets and away from reliance on bank balance-sheet funding. “If our total debt outstanding is €60 billion across all instruments, no more than 5% of that is bank funding,” says Mayer. “We can see that the availability of bank lending is limited by new regulations, but our whole funding strategy focuses directly on investors rather than bank lending and we feel quite safe from the restructuring of the bank sector.”
Most well-rated corporates now strive to keep committed bank lines available but unused in a return to the more conservative capital structures that prevailed a decade ago before many companies were pressed to lever up to buy back equity and acquire earnings.
Refinancing bank loans has been a driver behind many of the largest corporate bond deals in 2012. SABMiller attracted orders of $25 billion for its $7 billion yankee bond in January that refinanced the bank debt taken on last year in the acquisition of Foster’s. BHP Billiton raised $5.2 billion in February to refinance obligations.
“A huge amount of the supply in dollars has been about the terming out of bank facilities and commercial paper drawings into the bond markets,” says Mark Lewellen, head of European corporate debt capital markets at Barclays. “Corporates continue to look to diversify their sources of funding away from a reliance on shorter-term debt, especially in continental Europe where companies have traditionally depended much more on banks than in the US and where funding has traditionally leant on domestic institutions.”
Back to those Dealogic figures for investment-grade corporate DCM volume for the year to May 11. The figures show that in 2012 corporates have raised $182 billion in the bond markets compared with $113 billion from syndicated loans. Last year, over the same period, bond markets provided $118 billion of finance, compared with $210 billion raised through syndicated loans. In 2010, bond markets provided $126 billion and the syndicated loan market $167 billion.
Over the same period in 2007, as companies levered their way into the financial system crash, they raised $331 billion through syndicated loans and just $89 billion in the bond markets. Only once before has bond market volume exceeded loan market volume and that was in the banking industry’s crisis year of 2009. That year aside, banks have typically provided two-thirds or more of total corporate funding and capital markets one-third or less.
It appears a structural change is now under way, although Bamber at RBS warns against over-interpreting the figures. “Yes, the general shift from loans to bonds is a long-term trend driven by the easy availability of bond market finance to a wide range of companies and the regulatory pressure on bank pricing. But the primary short-term dynamic driving down loan volumes by 50% to 60% this year is that corporates are generally not borrowing new money. This implies a clear lack of the confidence to invest in M&A and capex even though the costs of borrowing are at historical lows of, say, 2% to 4% depending upon the issuer.
“The reason loans are down is that corporates are not borrowing and in future that will in turn drive lower bond market refinancing.”
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The shift from a reliance on bank funding to a reliance on bond funding has long been predicted in Europe, dating back to the birth of the single currency. Maybe it is finally happening. Some old habits die hard though. Bankers say European corporates still tend to analyse comparative funding costs on a Libor basis looking at credit spreads. In a nervous bond market such as the present one, credit spreads can widen, discouraging corporates from issuing even though on a fixed-rate basis, looking, as US treasurers tend to, at coupons or yields, borrowing costs are at all-time lows. It is often said that superior credit analysis skills among US investors mean that the US corporate debt market is always open, at a price, while the euro market is subject to periodic closure. Maybe the reality is that corporates periodically decline to issue and that fears of periodic closure of the European capital markets to corporates are overplayed.
“European investors will continue to fund their corporates,” says Baldini at Barclays. “Even if a country gets downgraded below investment grade; Portuguese investors, for example, are going to continue funding EDP. So when primary bond markets appear to close, that is often just a case of corporates sitting tight because they can afford to thanks to cash balances and modest funding plans.”
In any case, larger corporates in Europe have long since shifted to much greater reliance on bond markets than bank funding. Can small and medium-sized enterprises make the same shift, as increased capital charges and reduced wholesale funding lead banks to shrink their balance sheets and, where possible, gouge higher charges out of borrowers?
The answer might well be yes. Lundquist at Citi says: “You are starting to see smaller, often unrated companies in Europe issuing more bonds, typically primarily targeting their domestic investor bases for sub-benchmark-sized transactions. We have seen a string of these this year from Austria to Finland and that is a trend which is developing quite quickly.” Citi counts 16 debut or very infrequent corporate issuers coming to the euro market in the year to May 11, with deals ranging in size from €50 million to €650 million, with maturities ranging from two years to 12 years. Ratings range from Baa3/BBB- up to Aa3/A+, with seven of those issuers unrated.
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| Amandine Lezy, head of financing at Groupe Casino |
And once these companies gain experience in the public capital markets, other non-bank funding sources might open up to them. Lundquist says: “It’s hard to get precise data on the US private placement market, but it saw some $45 billion of issuance last year, its highest for nearly a decade. It is open to unrated companies and while the documentation and covenants may be similar to the bank loan market, maturities typically range from seven out to 15 years, which is quite a long term for an unrated issuer. Investors tend to be buy-and-hold and the pricing can be quite competitive.” If appetite for corporate debt remains strong, no doubt bankers will be urging companies to consider liability-management trades to retire older, higher-coupon bonds and replace them with new, longer-maturity debt at lower cost. Investors are increasingly concerned about the dire liquidity of older issues and might be prepared to tender into such auctions.
“There’s been an explosion in such trades in recent years as corporates have used them to smooth out refinancing peaks, which is something the ratings agencies view positively,” says Lewellen at Barclays. “The sophistication of such exercises has increased, with corporates now inclined to issue first ahead of the tender, rather than waiting for the tender expiration and potentially opening themselves up to market volatility on the new bonds.”
Groupe Casino has undertaken three such exercises: two in 2010 that exchanged old debt for new longer-maturity liabilities, and one last year that also brought in some new money. “Today, if we look at our upcoming repayment schedule, it is much smoother,” says Lezy, “so we have no pressing need to do another such exercise.”
