Borrowers awards 2003: Bookrunners contemplate a vintage year

Full list of winners

JUST OVER A month ago when Euromoney was interviewing US debt capital markets heads about prospects for the primary markets in May, pretty well everyone was gloomily predicting a quiet month. After a strong start to the year, US issuance in March and April had been disappointing. A lot of banks were predicting that the US primary business would be be down year on year, reasoning that with no immediate prospect of economic growth, a spurt of new funding was unlikely. Predictions for 2003 as a whole were that issuance would be as much as 20% down on 2002. “Five per cent to 10% down on the year could be optimistic at this point,” was one managing director’s bleak assessment.

Be wary of following these bankers’ forecasts.

A month on and the situation couldn’t be more different. In May there was a rush of new deals in the US markets as issuers took advantage of treasury bond yields at 45-year lows and historically narrow fixed-rate credit spreads. Total corporate issuance for the month was standing at $62.8 billion at press time and even in Europe, where supply has held up better all year, May also produced a bumper crop of new issues. At press time, overall supply in euros was up 17% year on year.

The primary markets are now utterly unpredictable. There was a dearth of primary-market activity for sustained periods last year, and it has been intermittent flood and drought in the US this year.

A lot of firms have been refocusing their efforts on institutional sales and trading or the structured products and derivatives arms of the debt business, which bring in higher fees. But any bank that neglected the less profitable, more run-of-the-mill underwriting part of the business is suffering the consequences now that the floodwaters are rising again.

Dealogic’s bookrunner league tables for international dollar bonds in the year to date, compared with the international dollar bonds done in May alone, illustrate this. The tables show that Citigroup and Lehman Brothers retain their first and second positions respectively, while Merrill Lynch and Banc of America Securities have improved at the expense of JPMorgan and Deutsche Bank.

Wylie Collins, head of the US issuer client group at Merrill Lynch in New York, was one of the few people that Euromoney spoke to in April who had a bullish outlook on the rest of the year. Indeed he was increasing staff to accommodate a pick-up in supply over 2002. His assessment was that CEO confidence was back, M&A supply was looking a bit more hopeful and that with 2004 providing a spike in maturing debt, there would be pre-funding of this in 2003. His take on the market holds true when looking at the international dollar deal flow the firm’s North American business is seeing. In May, it ranked third behind Citigroup and Lehman.

“We’ve had a good run recently, and with the historically low interest rates it’s been a great opportunity for issuers to reposition their balance sheets,” says Collins. “We’ve seen a wave of issuance due to pre-funding in the market as well as issuers extending their maturities opportunistically.”

Intense competition In the euro market, Citigroup came top for international euro deals in May, while the US bank ranks second to Deutsche year to date. Looking at the year to date as a whole, no-one can match the dominance of Deutsche Bank in this market, either in volume or number of deals.

Whichever bank is ahead in any particular month in Europe, bankers agree that the competition to win mandates is much more intense that in the US. “If you look at the top 15 banks in the market, they are all fighting it out for market share, says the head of one US bank’s European operations. “BNP Paribas has had a fantastic year and SG is doing well.”

In April, SG came out as the top underwriter by volume of German corporate bonds, challenging Deutsche Bank’s corporate underwriting strength in its home market. “We are doing well in Germany and Spain and looking to expand our position in Italy. We are refocusing and expanding our sales effort there,” says Marc Breillout, head of SG’s debt finance division. He claims that SG’s underwriting business is more profitable than Deutsche’s, despite the German bank’s league table predominance.

“The indigenous Europeans are back strongly this year,” agrees Charlie Berman, co-head of European credit markets at Citigroup. “But then there has also been a trend recently to have a lot more bookrunners on euro deals.” Both the euro and dollar tranches of Vivendi Universal’s $1.2 billion high-yield deal priced in April had five bookrunners, as did VW’s e4.5 billion equivalent multi-tranche jumbo transaction.

Michael Ridley, head of European syndicate at JPMorgan in London, says that for issuers to reward relationship banks with the chance to be one of many bookrunners on a juicy bond mandate is counterproductive. “Investors clearly value the additional liquidity offered by multiple bookrunners, but the benefit is negligible beyond two or three. In fact, investors generally react negatively to deals where the additional bookrunners are not well established in the secondary markets. We’re not concerned from a revenue point of view – we may have a smaller role in these deals but we’re doing more of them – but the result is that a confused and diluted message is sent back to the issuer. And it wastes an inordinate amount of time for the banks and for the issuers.”

Dilution of commitment He adds that the more bookrunners there are, the less commitment they have to underwriting a deal if things go wrong. “It is easier for one of them or all of them to say they won’t put their capital at risk. If you want to reward relationship banks you should write them a cheque for part of the economics but not make them all bookrunners.”

There is much more fee compression in the European market than in the US, a feature of the overall predominance of shorter-dated and less complex transactions as well as the greater competition. “In Europe, it is a volume business,” explains Ridley. “At the moment we are making more money this year because we are doing longer maturities and further down the credit curve, but obviously this is not sustainable. You may make more money doing 30-year maturities for issuers in euros but they are not going to be back to see you to refinance it during your career.”

Jorge Calderon, global head of debt capital markets at Deutsche Bank, which easily comes out top of the bookrunner table for all international bonds globally this year to date, says the fact that the bank is still making more money from its European primary market business than from anywhere else is a function of volume rather than margin. “Our European business continues to grow reflecting the increase in transaction volumes that we are processing in Europe. In contrast, the US markets are off pace compared to last year. “

Looking at that league table for all international bond issuance this year, Deutsche has done almost double the number of transactions that its nearest rival Citigroup has, although in volume terms Citigroup made a good effort to close the gap on its European rival in May.

“About 20% of all issuance that Citi has worked on globally has been executed in the last few weeks,” says Berman. “In Europe, the first quarter was tough for us on corporate market share but we have done many issues in the last few weeks and moved up to number four. In aggregate, 2003 has been good but at the moment things are unusually active and sentiment very constructive in both primary and secondary markets and across all asset classes. We think the forward calendar for the first few weeks will mean the first half of the year will have been pretty good for us.”

Another banker senses a change in mood among senior managers of the debt market business and that most of the major players are picking up business at the moment. “Before, at a lot of firms the fixed-income department was about cost containment, basically staying abreast of the number of people they had. Now fixed income is on fire and everyone is doing well at it.”

The flattening yield curve has driven underwriting volumes and resultant pricing that has taken everyone by surprise. “Seeing 10-year yields in the US below 3.5% is incredible,” says Berman. “We did a 10-year dollar deal for the World Bank at a record low of only 17 basis points over treasuries and an absolute coupon of 35/8. Since launch, rates have fallen another 20bp and IBRD’s spread is even tighter. And there was the fear that short-term interest rates would rise at the beginning of the year. Now, if anything, there is pressure for the whole curve to shift down again.”

Given the incredibly low long-term treasury yields seen in the US market, the drivers of this new surge in business, as investors hunt for yield, appear to be corporates. Until mid-May, industrial issuers formed a smaller percentage of the new-issue market than during the same period last year, but recently Johnson & Johnson issued $1 billion-worth of 10-year and 30-year fixed rate bonds and Viacom did 30-year and 15-year fixed deals, raising a total of $750 million through Banc of America Securities and Citigroup.

Collins at Merrill Lynch says corporates have been driving dollar issuance most recently, as investors searching for yield move down the credit curve. “Of the $17 billion of issuance the market saw in the week beginning May 12, $10 billion of that came from the corporate market,” Collins says.

There was also a flurry of agency and sovereign debt in the euro market in May, with Belgium, Austria, Depfa and ICO all launching aggressive deals, and the European covered bond market has been strong all year. But Heaney at Morgan Stanley points out that in Europe, too, corporates have been the main driver of the business all year. In mid-May, European FIG issuance was 7% to 8% up on the year, while for corporates it was up 15% on the year.

Within the corporate sector globally, larger deal sizes seem to be coming back in vogue. This is good news for bookrunners, which have been keeping up their revenue doing $150 million and $200 million deals, pandering to investor demands for rare issuers, which are not widely held or traded. “We keep saying the year will be defined by small deals but jumbos have been coming quite regularly – VW being the latest example,” says Berman.

Deals benefit from demand for yield Debut issuers have done well in this market. Mining company Anglo American, for example, issued a e1 billion five-year deal. Demand for yield is so great that issuers that had to pull deals during the worst of 2002’s volatility are getting them done now.

German media company Bertlesmann is a case in point. The company was forced to shelve its inaugural e1 billion seven-year issue last July after it had completed the roadshow, because of volatility in the technology, media and telecoms sector after the WorldCom debacle. It finally issued a e650 million seven-year deal in May, through Deutsche Bank, Citigroup, Dresdner Kleinwort Wasserstein and JPMorgan.

In the US, the experience is similar. General Dynamics did its inaugural $2 billion global bond last month; its first visit to the bond market since 1988. Banks, power companies and utilities have been active in the market this year, but business from frequent issuers is declining and, as one banker points out: “There’s not one sector driving the market in the US. First we had the CP realignment, then the telco realignment. Instead we are seeing names you wouldn’t expect or recognize.”

The worry is how quickly feast can turn to famine. As Euromoney went to press at the end of May, the dollar and euro markets had experienced a few days of selling pressure. Issuers coming to the market had seen their deals only just covered, rather than massively oversubscribed.

With the unexpected surge in supply and corporate yields following treasuries further down, investors can afford to be a lot more picky about what they are buying, if they are buying into new issues at all. “There has been pretty significant widening in the last few days. Investors in deals prior to mid May are likely to be disheartened with their investment returns given the current environment. This may affect their investment outlook in the near term,” says Calderon.

How long this spread widening will last and what impact it will have on the primary pipeline, if any, remains to be seen. “There’s been a debate about whether the recent spread widening has been a temporary pause or a fundamental turn,” says Collins. “We think it was a temporary pause.” However, at press time, the US high-yield market had seen its first net redemptions of the year. Moreover, the US investment-grade market only attracted around $700 million of new funds in the last week in May, a sign perhaps that the torrent of new funds flowing into the bond markets was slowing to a trickle.

Investors’ secular shift Heaney, for one, doesn’t believe it. “Contrary to popular opinion, the equity-to-debt trade is not going away any time soon,” he says. “Investment managers don’t change tack so quickly. They tend to put a trade on over the long term.”

Recent pressure on spreads has dented the strong rally observed by the market since last October, but it has hardly knocked it out altogether. “The European market may have softened 15bp over the last few days, but we’re still seeing 100bp lower return on a 10-year triple-B bond than we were two months ago,” says Ridley.

Bankers are now more reluctant to offer predictions for the rest of the year. The hope is that annual issuance levels may now be about the same as last year’s, but there are plenty of potential obstacles. “There’s no one thing that is an obvious problem, but there are numerous situations including the issues in the Middle East, tension in Korea, Sars and Europe’s recessionary environment,” says Calderon. “The timing off new issues will be critical to success.”

The bulls’ argument is that corporate treasurers in particular would have to be mad not to lock in fixed-rate funds at these sorts of rates, even if they don’t need the funds immediately. “It’s the big dilemma, do you come now for all-time-low coupon, even if you don’t need the money and run the risk of negative carry? But 2002 has taught us that the credit markets can open and close. Taking advantage of good times for financing, particularly at all-time-low yields, is something companies should increasingly be taking advantage of,” says Heaney.

He adds that European corporates should seriously be considering terming out their debt while they can. “Corporates are playing with their maturity profiles more than they realize. If they could have rewritten their history, how many fallen angels would have termed out when they were single-A or double-A issuers ?”

On this basis, he thinks there will be two dozen 30-year euro-denominated deals from corporates by the end of the year.

Meanwhile, Heaney points out that the maturity profiles of European corporate bonds are much shorter than in the US, where only half the market matures in five years. European bookrunners should have a lot of refinancing business to keep them busy. And Collins thinks there is still plenty to do in the US as well: “With the amount of refinancing still to be done, we think that issuance for the rest of the year will continue to be healthy, albeit not at record levels.”

“It’s a bit like predicting a good wine vintage,” says Berman. “So far the signs are good; no storms, the flowering has gone well, the sun is shining, no rot has set in, but until the crop is brought in you just don’t know.” With the experience of 2002 still fresh in their minds, underwriters are not taking anything for granted.

All international bonds year to date (May 22)

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