Those involved in raising money for sovereigns will be relieved to have got 2009 out of the way. They had survived nay, flourished in one of the most testing years in the history of the pubic sector bond markets, amid spiraling deficits, plunging GDPs, soaring supply and a depressed financial industry. But their relief will be tempered by the prospect of having to do it all over again in 2010 but possibly in even tougher conditions. Sovereign bond supply will remain high perhaps higher, in fact, than 2009 as public debt grows while central banks will be withdrawing their support for their economies a nasty combination that could well result in some investors running away from the asset class. Meanwhile, the threat of inflation will surely grow this year and there will doubtlessly be more sovereign shocks like the one Dubai gave us towards the end of last year to fray nerves even more. In the eurozone, Greece and Ireland are on top of the worry list and the US and UK have yet to convince the investor community that they are tackling their deficits properly. Faith in the ability of government bond markets to function efficiently and effectively will be tested like never before.
Emerging market bond issuers and investors had a fine time in the second half of 2009 deals came with increasing regularity and ever lower pricing. Asian sovereigns, banks and companies, were to the fore, Latin America behaved almost as if there was no crisis, and until the Dubai debacle the Middle East almost shed its EM status and made it to the developed ranks. But there a was country that offered few new deals: Russia. This year should be different, especially if, as seems likely, the sovereign issues its first debt internationally in a dozen years in the first quarter, helping other issuers from the country, too. If oil prices average $58 a barrel, Russia will sell $17bn of bonds in 2010 though with the price at over $80 in January, that figure will be lower.
Coco a go-go
Capital markets thrive on innovation and no product offers as much promise as contingent capital. Lloyds Banking Group led the way in 2009 issuing £7.5bn of lower tier two notes that, should its tier one ratio fall below 5%, magically convert into equity. Regulators want it for the additional buffer it provides on a going-concern basis. Issuers want it to meet stringent capital requirements without resorting to issuing (even more) expensive equity. And, with chunky yields, investors want it, too. Basel 2.5, with its injunctions against hybrid capital particularly innovative tier one in favour of common equity could provide another boost.
Corporate bond boom
The European corporate bond market had its best ever year in 2009 but there are signs that more could be in store for 2010. Last years Eu251bn of issuance, via 235 benchmarks, ushered in an era of unprecedented depth and liquidity as the continents largest borrowers made merry. Towards the end of the year, though, a succession of small and medium-sized issuers, many unrated, made their debuts. If that trend continues, the European corporate bond market could shake off its little brother status and truly start to rival the US.
Loan market strangled
Those corporate bond evangelists who at the beginning of the last decade preached the end of the loan and the coming of bonds in Europe have finally been proved right. But for the wrong reasons. They thought with the introduction of the euro bond market liquidity would grow to such depths and offer such flexibility and value for money that corporates would ditch loans and adopt bonds. But, as we know, the loan fought back with its own deep liquidity, low prices, long tenors, and a blind eye to covenants and other pesky alarm systems.
Unfortunately it fought back so strongly that it over-exerted itself and was a leading contributor, along with securitisation, to the financial crisis. Credit was crunched as banks stopped lending and the interbank offered rate soared.
While the rate has come down as confidence in the banking sector is recovering, the loan market has failed to return to 2007 form. In fact, 2009 saw global syndicated lending down 39% on 2008 to $1.81tr, the average tenor dropping to four years (the lowest on record) with the investment grade product surpassed by corporate investment grade bonds for the first time.
With the loan market unable to meet the demands of borrowers, many companies had their first taste of bonds last year, and many of them liked it. Showing what could be done was Roche, the Swiss pharmaceuticals firm, which bypassed the loan market completely in March last year when it financed its $47bn acquisition of the part of Genentech that it did not already own almost entirely in the international bond markets.
Even though the loan market will undoubtedly become more competitive this year, it will have lost business perhaps permanently as a result of last years coma, with more European CFOs than ever before prepared to trust the bond market as the source of much of their core term financing.
Securitisation and the ECB
Securitisation is in line for better times after its near-death experience during the credit crisis, and not just because of the reversion-to-the-mean tendency, or renewed jauntiness among investors on some clichéd hunt for yield. Securitisation is set for a revival for an entirely different reason: transparency regulation.
Foremost among the initiatives being taken is the European Central Banks push for loan level disclosure, particularly for residential mortgage backed securities, which, if implemented, holds out the prospect of a deeper, more resilient market.
Issuers will, initially, chafe at the requirement they rarely want to provide loan level data to investors, let alone the wider market and implementing disclosure will undoubtedly be costly, but the advantages outweigh those concerns. At last, investors will be able to do thorough credit work, and with regular updates on pool performance, will be in a much better position to discriminate in a crisis. A more informed investor base is a more sustainable investor base.
Equity inherits the crown
No longer the pauper, equity was crowned prince of capital markets in 2009. ECM revenues surged in the second half of the year as European and Asian companies and banks topped up capital and rebuilt balance sheets after the years of debt excesses: volume reached a quarterly record of $324bn in the fourth quarter. Rising stock markets did their bit to promote issuance, but whether the bull run continues or not, ECM bankers are sure to be busy. If markets keep rising, they are braced for a rush of IPOs as private equity funds offload assets at attractive prices. And if markets stagnate or fall, there will be plenty of companies and banks back in balance sheet-rebuild mode.
FIG refinancing to the fore
The coming year will be the one when the financial institutions sector comes off the intravenous drip of central bank liquidity support. That means beginning to refinance, on some estimates, over Eu800bn of cheap central bank funding in the capital markets. Regulators will expect the sector to get up and run too. That means extending average maturities from their shortest ever level to correct asset-liability mismatches and meet new liquidity tests. Expect a flood of longer dated issuance in both senior unsecured and covered bond formats keeping the new deal screens rolling.
Just before Christmas, Friesland Bank sold a Eu500m RMBS, but it wasnt just another deal in Europes fledging ABS recovery. It was the first public sale of a deal that had been previously been retained for repo with the European Central Bank an encouraging start to the inevitable sell-down of hundreds of billions of euros of such deals.
But as the central bank starts to withdraw its unprecedented liquidity support, there are fears that it may move too fast, too soon. If it does, a flood of such deals, many from weaker jurisdictions and with less than optimal collateral and structures, will be forced into the market, pushing out spreads and crushing the recovery.
Corporate bonds bust
Can anything stop the corporate bond bandwagon? A spurt of economic growth, especially if it comes with an inflationary twist, could strike the discordant note. One of the reasons that bonds became so popular with investors in 2009, particularly retail investors, was worries over equities after the post-Lehman Brothers horror show. Safety-first was for many the order of the day. But, with the bull market entrenched, and credit spreads still falling, there could be a shift back to shares. Throw in higher inflation expectations and bonds might not start to look like a sure thing after all.
Fixed income riches harder to come by
Risk premiums were higher than ever before, competition was low and asset prices were rallying. Perfect some say unique conditions that allowed those banks that had weathered the financial storm to rake in revenues in fixed income in 2009. But those conditions cannot last. Competition is returning as those institutions laid low by the credit crisis return to health, risk premiums are narrowing sharply as investors build up more courage and asset prices will return to 2007 levels as the economy recovers. Banks will have work a lot of harder to achieve the kind of FICC successes they enjoyed in 2009 and some will be forced to run faster to stand still, meaning more will have to take bigger gambles more often.
Last year may have turned into something of a boom year for investment banking, but there was for many a sense of making hay while the sun was still shining. The wave of new regulations following in the wake of the credit crisis threatens to raise the cost of many investment banking activities so much as to dissuade some from participating altogether.
Holdings in the trading book will face much higher capital charges, as will market risk in general. Tighter liquidity rules will increase bank investor demand for government bonds and decrease the appetite for other debt, potentially reducing private sector capital markets activity, while stricter regulation and exchange trading of derivatives may reduce profits.
Regulators are determined that no bank should be too big to fail and politicians insist that capital markets should serve personal and corporate banking, not the other way around. With many investment banks assets dwarfing their host countries GDP, deleveraging still has a long way to go.
Cheerful or fearful? What to watch out for in 2010
If the last year has been one-way traffic on the road to recovery, market participants can expect a rougher ride in 2010, with a much more diverse range of risks — and opportunities — in store. A possibility of a double-dip recession, the withdrawal of quantitative easing and more long-burning debt crises of the Dubai type could all make the coming year more volatile — and interesting — than 2009.