Europe's MTN market has always struggled to match the depth and breadth of its US counterpart, not least because of the lack of diversity among issuers in the market.
That is starting to change. Where until recently Euro-MTNs were the preserve of frequent issuers and, in particular, financial institutions, now corporates are embracing the opportunities offered by issuance off MTN programmes.
These issuers - backed up by the growing ranks of regional authorities, emerging market borrowers and GIC backed issuers from the US - are driving Euro-MTNs to become a market that is much more focused on credit.
AGAINST THE BACKDROP of a single European currency, a range of new issuers have been venturing into the Euro-MTN markets.
Leading the way are the type of issuer which, to date, have been the exception rather than the rule - corporates.
But the number of US insurance companies, banks, special purpose vehicles and emerging market countries is also increasing. At the same time, some familiar faces have been retreating from the market and some tried and tested issuance routes have changed.
The principal theme of the MTN market over the past year has been has been how much deeper it has become. "We have had triple and double-A banks approach the market, then single-A's, now triple-B corporates. This trend is likely to continue," says Pieter van Dyck, global MTN product manager at ABN Amro.
The degree to which corporates new to the debt markets have seized upon MTN programmes has surprised many intermediaries.
There is no doubt that, while the Euro-MTN market remains dominated by the finance and banking sector issuance in terms of number of issues, corporate issuance has risen substantially, albeit from a very low base.
It will take time for European corporates to grasp fully the opportunities on offer in the international debt markets. Many are hesitant about seeking a rating (although there remain many high profile, successful issuers without).
But European corporates have at their fingertips even more options than their US cousins, which bodes well for the development of the Euro-MTN market. European issuers, for example, do not have the problem of shelf registration in the US, which means public and private deals have to be separated.
Carolyn Coombs, executive director of Euro-MTN trading at Goldman Sachs, says: "Corporates are using programmes as a vehicle to do public deals. The establishment of a programme enables quick access to the market in public or private format whenever an opportunity arises."
For Daniel Cogoi, global head of MTNs at Paribas, the most striking change has been in terms of the way corporates are looking at their whole debt management strategies.
"When I started doing MTNs there was a predictable chain of events," Cogoi says. "First, a corporate got a rating, then it set up a commercial paper programme, then it issued bonds and then [after it had sold several bonds] it got an MTN programme," he says.
The new breed of corporate issuer has become aware that it can no longer raise all the money needed for expansion from the banking sector, which should push corporates to become more proactive about setting up programmes.
The change is in part a result of developments in the way individual banks and regulators look at EU capital adequacy requirements.
This could lead to an increased impact on the way banks look at their lending portfolios and the way that investors (which include banks) manage their securities portfolios. Moreover, the new breed of corporate issuer has large requirements that need to be satisfied in a hurry.
"Time pressure is an element. A lot of issuers now get a programme and the rating comes either at the same time or later," says Cogoi. After all, why do a bond issue first on a standalone basis when, at the end of the day, the time taken to set up documentation on an inaugural debt issue is not too much less than setting up an Euro-MTN programme, while the costs of doing the latter tend to be justified after two or three public issues?
COGOI POINTS TO French retailer Carrefour as an example of the new attitudes of corporate borrowers. "Carrefour was open in its reasoning that it made sense to be prepared for the fact that banks are not going to be in the lending business going forward. Carrefour looked at the disintermediation process and decided that there was a need to find fixed income investors," says Cogoi.
Paribas arranged the supermarket group's Eu2bn MTN programme, signed on July 1, 1999, and acted as bookrunner on Carrefour's debut transaction a Eu1bn fixed rate issue due in September 2004 which carried a coupon of 4.38%. According to MTNWare, Carrefour has issued a total of Eu1.46bn in securities in the year to August, including the public issue.
As well as deepening the investor base for MTNs, monetary union has also helped to foster a welcoming environment for corporate mergers and acquisitions. With takeovers come large financing needs - as in the case of Carrefour's proposed merger with fellow French retailer Promodès, announced nearly two months after its MTN programme was signed.
In the world of M&A, the need to raise money quickly is
often vital - making an MTN programme an ideal product. One trend
beginning to emerge is for acquisition finance to be raised through
the ECP market and refinanced through Euro-MTNs. The two products
There have been few better examples of an issuer exploiting the new pan-European appetite for Euro-MTN product than Tecnost, and few more compelling uses of an Euro-MTN programme for documenting a publicly syndicated deal in the new environment.
The debt financing of Olivetti's takeover of Telecom Italia was completed in grand style, culminating in the largest ever corporate fixed rate issue in euros being sold in late July.
Issued from its new Eu10bn Euro-MTN programme, the Eu4.5bn five year and Eu1.75bn 10 year bonds replace the Eu6.1bn bank facility put in place for the takeover, and came in addition to the Eu9.25bn of floating rate notes Tecnost sold in June (before the establishment of the Euro-MTN programme), taking the total Tecnost raised in the Euromarkets to Eu15.5bn in the space of just two months.
Bearing in mind that the largest fixed rate euro issue from a corporate before Tecnost was Mannesmann's Eu3bn 4.75% 10 year deal in late May, the sums raised almost beggar belief. Not long ago, an issue as large as Olivetti's would have solicited the advice to "go to the US". But the markets have changed dramatically.
"Prior to the introduction of the euro, an issuer, particularly one with a lower rating, would not have been able to raise such an amount in the European market alone," says Julia Ward, director and head of origination for Euro-MTNs and Euro-CP at Lehman Brothers in London.
LEHMAN BROTHERS acted as arranger on Tecnost's Euro-MTN programme, and as joint bookrunner (with Chase, DLJ, and Mediobanca) on the bank financing, the floating rate notes and the Eu6.25bn of bonds sold in July.
"The Euro-MTN programme was established to provide Tecnost with the most cost efficient way of issuing in the future," Ward adds.
Tecnost managed to garner a relatively broad investor base, broader than past Olivetti issues. Less than half of the bond was placed with Italian accounts, according to the leads, as against over 70% in previous Olivetti transactions.
Citing the importance of getting an expanded investor base for the new company, Luciano La Noce, director of corporate finance at Olivetti, contends that the European market is becoming much more than an aggregate of its parts.
"The European market is considerable in terms of size and depth, and as we discovered in the last six months, it has a larger appetite than we had expected," says La Noce.
Moreover, going to the US in the limited timeframe that Olivetti had for its bid was not a viable option. "It wasn't a very attractive time to access the US public market, so it was a good thing that Europe was large enough to absorb the deals," says La Noce.
The driving force behind the establishment of a Euro-MTN programme for Tecnost was to find a flexible instrument which the issuer can use from time to time in order to follow market demand and match that with the issuer's needs, La Noce explains.
But some bankers say the progress of corporate issuance in the
new euro market, with a few notable exceptions such as Olivetti,
has not been as dramatic as
"If you were to compare expectations with what has actually happened, there has been a lot of disappointment. The development of the market has not been as fast as we would have hoped," says one European investment banker.
After all, a few high profile public issues do not create a deep market. "If anything, there is still a lack of European corporate borrowers. The huge growth in European money funds has created strong demand for spread and corporate product," says Gavin Eddy, executive director at Warburg Dillon Read.
"While corporates are one of the fastest growing sectors, we still find it difficult to source single-A/triple-B names, beyond the dozen or so obvious candidates."
Even within the double-A rated arena, high profile sectors with large capital outlays such as telecoms have not seized upon MTNs as anything other than a vehicle for public issues. They have certainly not exploited private placements to their full extent.
But for many corporates, it is still early days in their capital market experience. Vodafone's $61bn merger with AirTouch led to the company setting up a $10bn issuance facility in April through Goldman Sachs. A large and immediate need for funds made Vodafone/AirTouch an ideal candidate for the Euro-MTN product.
"We will refinance debt in the capital market, initially on a public or syndicated basis, but we may review the situation," says a Vodafone spokesman. "In the past we have launched one-off issues. The three things that attracted us to an MTN programme were its flexibility, the fact that it is advantageous on the timing front and the speed with which we can launch issues. It is also cost effective."
Mike Bransford, associate in the Euro-MTN trading division at Merrill Lynch, disagrees with the idea that the market is too thin. "I don't see any lack of corporates," he says. "In the past, the MTN market was more or less closed to corporates. Now there are plenty working their way through the system."
As far as corporates continuously offering products is concerned, Bransford sees around half of the corporates that have programmes aggressively showing levels, and the other half interested in reverse enquiry but not necessarily posting rates all the time.
"Corporates are definitely where the growth in the MTN market is," says Henry Nevstad, senior associate director at Deutsche Bank. But he is disappointed that demand is not as robust as had been expected.
"Investors are increasingly going down the credit curve, but it is happening more slowly than most had hoped."
Van Dyck at ABN Amro discerns the beginnings of a more of a fundamental shift in attitude. "Corporate issuers are adapting the way they think about financing, and it's no small change," he says.
"MTNs allow them to be active at any time, while loan financing tends to be once a year and larger. It requires a different approach to how to manage liquidity altogether. A lot of companies have commercial paper programmes and are running up debt in the short term markets and refinancing it in the longer term markets via MTNs."
AWAY FROM THE corporate market, the spectrum of emerging market sovereign issuers of Euro-MTNs has "divided into the haves and have-nots", according to Jonathan Stanley, director, central and eastern European capital markets at Nomura International in London.
"The fast track EU countries pay Libor plus 50bp, but a double-B rated issuer can pay 300bp-400bp over."
For those in the top funding group access is easy and cheap, even compared to pre-Russia crisis days. But outside the select band, particularly those not gaining from the comfort of the proposed fast track to the EU, spreads have widened dramatically.
The Czech Republic is the only eastern European sovereign to have established a Euro-MTN programme.
"The Czech Republic is preparing for its first appearance in the international capital markets in its own name and the choice of the Euro-MTN programme as a platform for ongoing issuance is an important endorsement of the product," says Deborah Loades, MTN product manager at Morgan Stanley Dean Witter, arranger of the programme.
She adds: "The programme is expected to meet strong demand from the investor base who have credit lines in place for EU accession countries but have been suffering from a lack of supply from the region as a whole, and particularly from the Czech Republic. There are only two Czech government guaranteed issues outstanding in the market, totalling less than $500m."
Other sovereigns in the region are reported to be looking into the prospect of launching Euro-MTN programmes. This could lead to a sharp growth in supply from central and eastern Europe as, when the state sets up a programme, often it opens the floodgates for banks and corporates with large borrowing needs to issue debt through the same mechanism.
For instance, analysts say that if Poland sets up an MTN programme, national telecoms company TPSA will not be far behind.
Municipalities and regions remain a good source of new programmes, although the pace of growth has not been as fast as many anticipated. Many European governments have slackened the constraints for municipalities and sub-sovereign borrowers over recent years, though the extent of development of the municipal sector varies between countries.
There is a strata of sub-sovereign or agency international issuers emerging, such as BNG in the Netherlands. The German Länder have been attracted to the MTN route, with issuers such as Saxony-Anhalt setting up a programme last year and Schleswig-Holstein tapping the Euro-MTN market early in 1999.
In April, Land Hessen mandated Deutsche Bank to arrange a Eu5bn programme which will be signed later this year.
But it is the Italian regions and municipalities that have led the way in setting up programmes. Following on from the region of Lazio's global MTN programme in 1997- the first ever for a sub-sovereign European borrower, arranged by Merrill Lynch - have come other Italian municipalities and provinces. This year, Italian cities such as Florence and Rome, and the Province of Naples, have all set up programmes.
All have been eager to show their long term commitment to issuing debt internationally by initiating debt issuance programmes rather than standalone bonds.
Florence set up a $300m global MTN programme (also known as "renaissance bonds") at the end of April. Arranged by Merrill Lynch, the city inaugurated the programme with a $29m 144A issue targeted principally at US investors.
In May, the City of Rome became the first Italian city to sell bonds off an MTN programme denominated in euros. Its Eu500m Euro-MTN programme was arranged by JP Morgan, which also led its debut Eu133m 20 year issue.
IN COMMON WITH all municipal issuance in Italy, the bonds amortise in equal instalments from the first coupon payment date. The bonds were placed with a wide range of European accounts.
The Province of Naples, rated Aa3 by Moody's, followed suit with a Eu33.7m 15 year floating rate note launched off its new Eu250m programme (arranged by Merrill Lynch). This marked the first foray of an Italian province into the international markets.
In a continuation of the trend of previous years, a number of Euro-MTN programmes have been set up for special purpose vehicles. One such SPV to have launched a programme has been the Dutch Housing Association Finance (DuHAF).
"DuHAF was the most challenging and exciting mandate of the year due to the complexity of its structure and the issuer's enormous potential for growth," says Loades at Morgan Stanley Dean Witter of the Eu1bn programme arranged by MSDW and Rabobank.
DuHAF is a special purpose vehicle that issues debt securities and lends the proceeds to Dutch housing associations that are also shareholders in DuHAF.
There are approximately 20 members of DuHAF, but more than 700 associations in the Dutch public housing sector in total, accounting for more than 2.4m homes or 40% of the total housing market. "The number of participating associations is expected to increase dramatically," says Loades.
A rival SPV exists in the form of Colonnade, an asset backed funding vehicle which already offers the Dutch housing associations the benefits of pooled funding, although both are very different in terms of execution.
Loades adds: "DuHAF's notes are expected to be well received by investors as they benefit from a triple-A rating and a zero per cent risk weighting, and they will become highly liquid as more housing associations enter the market through the innovative DuHAF issuing entity."
The beginnings of an MTN market in which securitised deals are offered on a continuous basis is not far off. "For a lot of credit card receivables, for instance, done on master trusts, it wouldn't be a huge leap to have a continuously offered shelf," says Ian Harjette, director and head of structured debt syndicate at Nomura International.
But there are always going to be limits. "We tend to look at securitisations with more esoteric corporate cashflows and uncertain earnings, which would not be as suitable [for the MTN structure]," Harjette says.
New programmes from banks have not completely dried up, although most larger European banks now have one. A greater number of European borrowers are setting up MTN programmes where in the past they would only approach the loan markets.
AlphaCredit Bank is one such issuer. The largest private bank - and second largest bank - in Greece, AlphaCredit signed its first Euro-MTN programme in July this year.
Lehman Brothers arranged the $1bn programme, with a dealer group comprising Lehman, CSFB, Merrill Lynch, Morgan Stanley Dean Witter and Salomon Smith Barney.
The programme provides for issuance of senior and subordinated debt (the latter is almost standard now for bank programmes) in a variety of currencies in a variety of markets.
As a tool for raising medium term funding, George Georgiou, AlphaCredit's group treasurer expects the MTN programme to be of great use.
"Greek issuers have not been tapping the capital markets to raise medium term funding, they have been mainly using the two year syndicated loan market," he says. "As we are applying to join the euro in the first quarter of next year there will be a demand for Greek assets. It is a very good convergence play for investors."
Timing is a problem, however. "We have done a roadshow to introduce the Euro-MTN programme and had a lot of interest and we have been approached by counterparties," says Georgiou.
But AlphaCredit is holding off on its inaugural bond from the programme because it has a split rating since Moody's upgraded it from Baa1 to A2, and it is concerned about a market slowdown in the run-up to the year 2000.
ANOTHER FEW MONTHS should not make a difference though. "The programme was a project we worked on for over a year," says Ward at Lehman Brothers. "It was almost ready when the markets collapsed last summer unfortunately delaying any issuance off the programme. Providing the markets are receptive, AlphaCredit should be ready to make its debut in the coming months."
US bank issuance into the Euro-MTN market may have eased partly as a result of the implications of the FASB regulations (see following box on page 12).
But it has also been the result of the increased supply of better known European credits.
However, a new breed of US issuer has come to the market over the past 12 to 18 months, although it is a development that has barely registered on many screens. "1998 and 1999 have been the years where the GIC backed (guaranteed investment contract) sector has taken off," says Marc Falconer, vice president of Euro-MTN trading at Salomon Smith Barney.
It comes as a surprise to many about just how large the sector has become. "A lot of people will be staggered that GIC backed issuance is in excess of $11bn outstanding, and that's a conservative estimate," says Jane Guttridge, executive director of capital markets at Morgan Stanley Dean Witter.
GIC backed issuers have roadshowed extensively in Europe, explained their credit and structure competently to investors and have shown a capacity to issue difficult structures and be demonstrably flexible in their approach.
Typically double-A rated (except, for instance, Sun America, which merged with AIG and benefits from its higher rating) and open to structured type transactions, they achieve enhanced pricing on programmes and are proving extremely attractive to European investors. "GIC backed issuers are starting to clean up in the 10-year plus sector," says Tynan at Lehman Brothers.
New investors have been filtering in to the GIC backed sector. "The deals provide very nice yields as double or triple-A rated names, as long as the investor can understand the credit. They have filled a part of the spectrum, namely well rated paper with spread that had been [underrepresented]," says Olivier Jalouneix, executive director at Morgan Stanley Dean Witter.
Morgan Stanley has arranged four out of the five new programmes to come to the market this year (Jackson National Life Funding, Allmerica Global Funding, Mass Mutual Global Funding, Allstate Life Funding), and has a further three programmes in documentation.
Jalouneix's caveat "as long as investors understand the credit" is key. After all, there is quite a lot to comprehend.
GIC backed issuers use offshore funding vehicles as it is tax efficient for them to fund outside the US. The key is that the parent issues a guaranteed investment contract, which in some US states is treated like an insurance contract in that it ranks above senior debt and the investor is treated in the same way as a policyholder.
The GIC has exactly the same cashflow as a bond issued by the funding vehicle, and the investor/bondholder has a claim on the GIC.
"It is an extension of our US business to take deposits and credit a guaranteed interest rate," explains Victor Gallo, vice president at Jackson National Life.
"With Euro-MTNs you can take deposits by issuing notes via a special purpose vehicle. The SPV then purchases an insurance contract also known as a funding agreement, which is held in trust as collateral for the noteholders. As an insurance contract, the funding agreement is in the seniority hierarchy above debt."
However, it should be cautioned that seniority rules are specific to the state in which the insurance company is based. Although the vast majority of states treat funding agreements as senior to debt, investors should check the small print.
The road to GIC backed issuance has not always been smooth. Some of the original deals were perceived to be not particularly well supported by dealer groups.
In the early days, too, many investors misunderstood the fact that issuance via a special purpose vehicle did not automatically mean that there would be a securitisation lurking behind.
"SPVs always smell and look like asset backed to investors," says Guttridge. "And there frequently used to be asset backed deals as benchmark pricing which had an effect on expectations which did not fairly represent the value of the assets."
However, GIC backed issues have none of the normal complications of asset backed securities, such as different classes of assets, different prepayment options, and different tranches.
"The deals are about as lightly structured as you can get - a straight passthrough from funding agreement to noteholders dollar to dollar (or euro to euro)," says Gallo.
"Once investors look at the structure, they find that the evaluation is like a straight corporate credit that requires them to do standard due diligence on the company." Indeed, the GIC backed bonds are part of the general obligations of the company behind the issue, not just the assets in trust.
There is also the element of confusion as a result of different treatments of GIC backed issuers by ratings agencies. Moody's rates issuers a couple of notches below Standard & Poor's, because it perceives a risk of the issuers not being rated pari passu and so being structurally subordinated to, say, other triple-A organisations. S&P considers that the likelihood of default of a triple-A organisation is close to zero.
Meanwhile, Gallo says that his firm's main reason for coming to Europe was to expand the customer base. Moreover, with tenors on offer of over five years, the institutional market in Europe is a good fit with Jackson National Life.
Since the $2bn programme was launched in April, the company has sold $700m worth of Euro-MTNs, mostly via reverse enquiry. While most has been five years and longer, the firm has issued as short as two years.
What are the limits to GIC backed issuance? "I don't think the supply will be turned off again," Guttridge says. "Although a large number of investors are buying GIC backed paper, they don't always buy big chunks."
THAT DOES NOT MEAN they are concerned about the credit - rather they want to see how GIC backed bonds trade. "If they see they trade like vanilla, demand will increase," she says. "I expect to see demand expand to the rate of growth of supply and spreads to fall."
Guttridge points out there is a natural cap to supply, as each issuer has said they don't want to sell more than a certain proportion outside the US.
But Gallo does not see any major caps to the potential size of GIC backed issuance in Europe, though. "The US GIC and funding agreement market has about $200bn outstanding with US institutional buyers. We are expecting to see more supply of these Euro-MTN programmes and, over time, better costs. I don't see why the market shouldn't be $100bn globally down the road," Gallo says.