Take advantage of top grade corporate debt

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Investment-grade companies are enjoying an unprecedented era of attractive funding as investors scramble for a decent return in a shrinking universe of safe havens. But, says Myles Clarke, Co-Head of Global Syndicate at RBS, such firms must still be careful or the volatile economic climate could jeopardise an issuance.

Myles Clarke, Co-head of Global Syndicate, RBS
Demand for investment-grade corporate debt – that is debt rated BBB or higher – has never been stronger. Media firm Bertelsmann, for example, paid a 7.875 per cent coupon for a five-year bond in 2009. Three years later the German conglomerate is paying just a third of that for debt with double the maturity.

Yields, which move inversely to prices, have fallen thanks to a simple reality: there is more money chasing fewer assets.

Nerves over the eurozone crisis and its effect on global growth have prompted investors to pare down their exposure to stocks and spurred an unprecedented flow into safe haven assets. Whole investment streams, which once soaked up trillions of dollars, appear blocked.

Demand for property and asset-backed securities, which were massively popular in the mid-2000s, has slowed to a trickle. At the same time many traditional safe haven alternatives have either vanished or hold little appeal. Swathes of Europe’s sovereign debt market are shunned by investors, most notably Spain and increasingly Italy, the world’s third largest borrower. The subsequent switch into bunds, gilts and Treasuries has depressed yields to such an extent that investors are effectively paying the German government to hold their money.

The European Central Bank, Federal Reserve and Bank of England have all swelled this surplus pool of cash with liquidity injections. The ECB’s longer-term refinancing operation (LTRO) has been a game changer in this respect. By washing EUR1 trillion through the financial system in December and February the ECB gave many financial issuers a funding avenue that allowed them to by-pass the bond market, thus further reducing supply.

Central bank liquidity injections, combined with the narrowing number of large, liquid markets still attractive to investors, has created a pool of surplus capital worth trillions of dollars.

All of this means that corporate bonds are now attracting interest from those who would normally opt for safe government paper as well as from higher-risk players who would, in better times, be dabbling in stocks and lower-grade bonds.

So far this year, investment-grade companies in EMEA have issued EUR127 billion of bonds, already beating the total issued in the whole of 2011, as companies take advantage of historically low rates.

So why are more companies choosing to issue debt now, given that risks surrounding the eurozone have arguably increased in 2012? Despite the euro’s future now being openly questioned, there is a growing sense that investors have grown used to the worries which, late last year, all but shut down the market. The Vix index, a measure of market volatility also known as the ‘fear gauge’, has fallen markedly (see graph overleaf). The ECB’s liquidity operation is part of the explanation here, but it is increasingly the case that investors are feeling less queasy as they ride Europe’s political rollercoaster and are choosing to take the plunge into debt.




It’s all in the timing


Large, credit-worthy corporates would seem to be in an enviable position, especially given that central banks seem unlikely to end the party and tighten monetary policy soon.

But the situation is not rosy for all such firms. In peripheral Europe, even large, defensive stocks, with steady revenue streams and foreign exposure are paying a premium because of market fears that their home country may drop out of the euro and redenominate debt in a new, less valuable, currency.

Europe’s economic battles can still wound large corporates, even in more stable markets.

In today’s febrile atmosphere one poor sovereign bond auction, an unexpected election result, a misinterpreted central bank comment or a piece of disappointing data has the power to abruptly reverse global sentiment. That could have a drastic impact if it happened just as a company was pricing a bond issue and might prompt nervous finance directors to cancel the move altogether. Getting the timing right will be more important than ever over the coming year, as matters come to a head in Greece and Spain and markets digest the implications of a possible change in the White House.

Today’s volatile environment demands bold thinking from finance directors. Rather like a racing driver picking his moment to exit the pits for a qualifying lap, they and their bookrunners must precisely judge conditions and potential obstacles before fixing on the week, day, even minute to go to market. A few years ago, a bond issue might have run over two days. Today companies often need to get in and out within two hours.

The message to investment-grade companies is simple. Borrowing is cheaper than at any time in recent history, so don’t be too greedy: when a funding window appears, don’t try and knock an extra point off the coupon. Act fast or risk the volatile economic climate jeopardising the whole transaction. 

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