On the road to a credit market

  • 01 Jun 1998
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Italian borrowing in the international capital markets is growing rapidly in the run-up to European monetary union. A wider range of corporates is starting to use the bond markets, diversifying away from bank financing and providing new investment opportunities for the increasingly institutional investor base in the domestic market.

New Italian bank issuers are starting to emerge in the MTN and bond market, while local authorities are becoming increasingly frequent and adventurous borrowers in international markets.

And Italian issuers have been among the quickest to take advantage of the new opportunities in the fast-developing euro bond market. Eugénie Latter reports.

In Italy, as elsewhere in Europe, borrowers are becoming increasingly aware of the funding opportunities available in the bond markets.

Over the last two years the capital markets have welcomed the arrival of a number of new Italian names. Although banks remain the largest of Italy's bond issuers, corporates and local authorities look set to play an increasingly prominent role.

The growth of a corporate bond market is one of the most significant developments in the Eurolira market over the last two years. In 1995 just one issue, a Lit50bn for Lucchini, was launched in the public Eurolira market, while 1997 saw the issuance of 10 deals totalling over Lit3tr.

This year has also been busy, with over Lit1tr launched for corporate names. Corporate debt is currently the fastest growing sector of the Eurolira market, with corporates almost doubling their share of the market to 20% in the first five months of 1998.

Lower yields and the advent of the single European currency have played a major role in changing investment attitudes in Italy and encouraging the development of a more credit oriented market.

"Volatility is quite low, currency risk is basically no longer there in Europe and the absolute level of rates is low so the name of the game, especially for institutional investors, is to play the credit game effectively, looking at diverse credit opportunities and analysing corporate risk," explains Alessandro Mitrovich, newly appointed senior country officer at Chase Manhattan.

"Spreads on corporate bonds will shrink if the credit improves or the perception of the credit improves. The potential for credit improvement is what investors will be looking for."

The dramatic rally in the Italian bond markets in recent years as Italy moved towards Emu - with Italian bonds converging from 600bp over Bunds to around 25bp - has caused retail investment patterns to change.

Encouraged by the wave of privatisations and the boom in the stockmarket, private individuals are increasingly investing in equities and mutual funds in the hope of earning higher returns.

While the government bond reinvestment rate among individuals stands at only 5%, the growth of managed funds has been quite spectacular: by the end of May they were already managing some Lit650tr, which represented a increase of 40% on last year.

And as money moves into funds, institutional investors will play an increasingly prominent role in the bond markets. "As banks push investors more and more into asset management, we will see institutional investors counting more in the investment scenario. Retail investors will lose their power going forward," say Niccolò Nuti, head of new issues at Credito Italiano.

"This means that corporate borrowers that need to tap the market will have to rely more and more on institutional investors, who are becoming more equipped to do credit analysis."

There is room for further growth. In Italy the proportion of money going into funds is still small at approximately 40% of GDP, compared to the OECD average of 104% of GDP.

The growing power of the institutional investors, combined with the coming of the euro, is providing a strong impetus for the greater development of a credit market in Italy.

While retail investors are keen supporters of emerging market names and will buy household names such as Parmalat, professional investors are the main sponsors of corporate debt, asset backed issuance and credit instruments such as subordinated debt.

The growth of the corporate market will only be accelerated by the arrival of the single currency market, says Enrico Cantarelli, senior manager in debt origination at IMI.

"Italian borrowers will no longer have to limit their horizons to the lira market and its investor base," he says. "In the larger euro market there will be room for bigger deals and more borrowers. The concept that there is a price for everything will develop in Europe."

Many borrowers, however, are still able to fund themselves at very cheap rates through the bank market. But market participants say this is changing as restructuring in the banking sector forces banks to pay greater attention to return on equity. Eventually this will lead to greater disintermediation of lending.

"Italian banks are realising that they can't carry on lending money at silly rates," says a syndicate official at JP Morgan. "Banks in Italy used to be public and as they were not particularly concerned about return on equity, they would lend money at below market rates. This is now changing and we are seeing greater competition between the loan market and the bond market."

He adds: "Companies are still paying a little bit more in the bond market but the difference is marginal. By going to the bond market, the borrower is getting its name known in the capital markets which it will hopefully be able to tap in the future at more attractive rates."

One company that has used the capital markets extensively and with a degree of innovation is food company Parmalat. The best known and most prolific of Italy's corporate borrowers, Parmalat has issued some $2.4bn in the public markets since it first tapped the international capital markets in 1994.

Besides tapping the market for straight bonds and floating rate notes, it has also launched a euro denominated convertible bond, raised 30 year money through the issuance of Lit1tr zero coupon bond, brought a three tranche preference share issue, and issued a Eu500m floater - one of the first corporate issues in the new euro bond market.

Parmalat's capital markets history is extremely impressive. "Corporate borrowers want to tap the market for a number of reasons: to diversify their funding sources, to extend their maturities and to lower their borrowing costs," says Mitrovich.

"Parmalat has done all of this. It has managed to increase its profile and gradually lower its borrowing costs both directly and indirectly - indirectly because I'm sure that its success in the bond markets has forced its commercial bankers to lower their spreads for short to medium term financing."

Both the Parmalat and the Olivetti euro issues launched this year enjoyed very positive receptions in the market from international as well as Italian investors.

In the case of Parmalat, the name and stature of the company have played an important part in its success as a borrower. For Olivetti, a company which has endured some tough times and came close to bankruptcy a few years ago, the success of its first capital markets issue for a number of years was a notable achievement.

Slated as a Eu300m issue, the deal was launched - after extensive pre-marketing - as a Eu400m five year deal at a spread of 128bp over the Ecu BTAN.

It was increased on the day of launch to Eu600m as a result of unexpectedly strong follow-through demand. Lehman reopened the transaction for a further Eu100m some weeks later at a higher issue price and a tighter spread.

Syndicate managers involved in the transaction - led by Lehman, a bank which knows the Olivetti credit intimately - put its success down to successful pre-marketing of the restructuring story and attractive pricing.

For Olivetti the deal was a great strategic success. "Olivetti used to be a PC company but they restructured their operations and they are now a telecom company. Tapping the bond market was a strategic step for them. They were selling the turnaround story and promoting the company's new image," says Lorenzo Frontini, director on the syndicate desk at Lehman Brothers.

"They could probably have funded themselves in the domestic loan market at a slightly tighter level but this was a strategic deal for an issuer which will potentially be a future player in the Euromarket."

Launching in euros appears to be a recipe for success. Parmalat's Eu500m seven year floater was also well received. Its success was down to wise pricing, according to JP Morgan, joint lead manager of the deal with Paribas.

"We categorised Parmalat as a single-A issuer and the spread they paid was broadly in line with that," says an official at the bank. "It paid slightly more since it was the first corporate to tap the euro market and because the company has no formal rating, but the company realised that it was more important to do a successful issue than save a couple of basis points."

Issuing in euros is one of the best ways to achieve broad international distribution. "Issuing in euros is the fastest way for an Italian corporate to reach a pan-European audience, but to do a euro denominated issue you either have to be a well known issuer or you have to undertake a lot of pre-marketing," says one banker.

Parmalat still dominates the corporate bond market in Italy - accounting for 30% of corporate issuance in the Eurolira market since 1995. But the market is gradually becoming more diverse.

Alongside frequent issuers like Parmalat and CIR a number of smaller companies have appeared in the market. These include RDM, Presinvest, Merloni and most recently Prada.

Italian investment banking group IMI has brought many of these companies to market and has also lead managed a number of private placements for Italian corporates over the last couple of years.

One of the most familiar names to come out of Italy is fashion house Prada, which brought a Lit250bn transaction in March this year. Originally planned as a Lit 150bn issue, the deal was upped on the back of extremely strong demand - which, according to lead manager IMI, could have accommodated a Lit600bn issue.

The deal was universally praised by syndicate managers, who pointed to the cachet of the name as one of the strongest factors behind its success.

But it was not just the appeal of the name that brought investors rushing to buy the bonds, say IMI bankers. Genuine investment arguments also lay behind its success.

"Prada tries to do as much as possible in-house in terms of production and distribution. They try to own all their stores all over the world and that is why they need more money than a traditional fashion designer," says an IMI official. "It is a great success story which has been proven by its very rapid expansion. One of the unusual features of the transaction was the strong bid for the paper outside Italy. Some 40% of demand was non-Italian."

A number of the corporate transactions launched in the lira market have been acquisition driven. They include Reno de Medici - a cardboard manufacturer, which issued Lit150bn four year bond to finance the acquisition of industrial rival Saffa - and cement manufacturer Presa - which issued a Lit300bn-issue to help fund the buy deals out out of Unicem.

Both deals, paying coupons of Libor plus 50bp, met strong demand - thanks to the lack of Libor plus product in the market at the time of launch. The Lit500bn five year transaction for Benetton lead managed by IMI and JP Morgan was another acquisition driven transaction, helping to finance the purchase of Benetton Sports Systems.

M&A activity in Italy is likely to rise sharply as a result of the single market and greater concentration on shareholder value and return on equity. As a result, acquisition financing should also increase, particularly through bond issuance.

The same themes are also causing high-yield issuance to rise. A Lit250bn issue for food group Cremonini, launched at an all in level of 250bp over Libor, offered the highest spread yet in the market.

IMI was bookrunner on the transaction while Bankers Trust, a leading player in the US and European high yield market, was joint lead.

The journey from conception to execution was far from smooth, partly due to the troubles in Asia, and the price talk widened. But it met with success when it surfaced in January, paying a coupon of 240bp over Libor. At this level the deal proved attractive to investors, while it also made good sense for Cremonini, says IMI's Cantarelli.

"The capital markets can sometimes have advantages for the more speculative grade corporates by allowing them to move away from their traditional sources of finance such as banks, which rely on asset coverage and guarantees," he says.

"Institutional investors will look at the credit story. Cremonini, for example, had a very high leverage but its turnaround story was very credible and it had a very strong management team. By focusing on those factors we were able to sell five year notes with no security on the company's assets."

He adds: "It was difficult for the banks in Italy to recognise an improvement in the activity of Cremonini as traditional credit analysis is asset based rather than cash flow based. But the bond markets reacted very favourably to the issuer and, by raising funds in the bond markets, Cremonini did not have to use its credit lines and showed the banks that it was able to access another source of financing."

Before the launch of the Cremonini bond, the highest yielding Italian corporate bond was a Lit250bn seven year transaction for Standa, Italy's second largest retailer of food and non-food products, which came at 99bp over three month Libor.

Like Olivetti, Standa is a very well known name which had been through tough times and was selling investors a restructuring story. Investors liked it and the deal was a success for Standa, which was able to raise Lit250bn of seven year money without posting profits in the previous year.

Bankers see the high yield market as an area of potentially large growth. "A lot of issuers which would be junk bond issuers have in succeeded in past in raising funds from their banks," says one banker. "Small regional banks have very strong links with local corporates and, while they have constituted a large part of the bank's business, the bank in turn would give them funds at out of market levels."

He adds: "Now that there is a process towards consolidation and a lot of the small banks are getting bought, this close relationship is coming to an end. Companies are aware of their dependence on the linkages with the regional banks; now that their ability to raise funds could be jeopardised, they are keen for investment banks to explain the ins and outs of the bond markets."

Although the loan markets can offer very competitive rates, the lack of high yield product in the Italian bond market has meant that these companies have been able to tap the markets at better levels than a comparable credit could achieve in dollars.

Says one market participant: "Cremonini, despite the fact that it was repriced upwards, was not a generous deal, and Standa came to the market before the Asian crisis at 99bp over, which was really quite tight. But at the time everyone was so hungry for yield they bought it, even though Standa would have paid a higher spread in a dollar context."

Bankers expect to continue to see medium and smaller companies tapping the markets. But whether Italy's blue chips will access the bond markets on a more regular basis is a matter of debate.

Nuti believes that the corporate market will continue to be dominated by small and medium sized companies. "The bigger companies in Italy do not tend to come to the market that often as they seem to be more liquid, and do not tap either the syndicated loan or the bond markets," he says.

"What we are seeing are some of the smaller companies tapping the markets, perhaps because they have limits on how much they can borrow from banks or because they are just quicker to grasp the opportunities offered by the capital markets."

Others disagree. "The big blue chips in Italy will become more frequent issuers in the capital markets because they, like other issuers, will be forced to look at the bond markets as the banks focus more strongly on return on equity," say an official at JP Morgan.

How fast and in what direction the corporate market develops in Italy is open to question. But one thing is certain: demand for corporate paper is there, at the right price. Indeed demand for all credit instruments is growing as the investor base becomes more diversified and more focused on credit analysis.

"Now most of the big fund management companies have someone in charge of credit analysis, which wasn't the case one or two years ago," explains Cantarelli. "While the Lit150bn issue for De Longhi, launched almost two years ago, was mainly placed with banks, the more recent issue for Prada attracted extremely strong demand from institutional investors and could have been placed twice over with mutual funds."

The relative immaturity of the market is evident in the fact that virtually all corporate issuance to date has been in floating-rate form, with the exception of Parmalat and Fiat, two household names.

"Almost all the Italian issuers to have tapped the lira market have done so in floating rate form," says Cantarelli. "This is because the market is in its initial stages."

But the market is maturing as the number of investors and issuers increases. "When there were very few corporate borrowers in the market it was difficult for investors to trade out of one deal and into another," says one banker. "Most were bid only. With a deeper and more diversified market you will be able to do more relative value trading which will encourage the greater issuance of fixed rate corporate bonds."

The introduction of the euro should encourage greater international participation in these deals and eventually lead to the establishment of a European credit market.

A more competitive capital market should lead to more Italian companies getting ratings. One of the most striking aspects of the Italian corporate market at the moment is the lack of ratings. But this is changing.

Eni recently became the first Italian corporate to receive an international rating when it was assigned an AA long term rating from Standard & Poor's last month. And bankers say others will follow suit.

"Issuers have to stay competitive, they can't afford to allow competitors gain a competitive edge," says one. "Once one company has a rating more will follow."

Despite their high profile and their recent successes, corporates still account for just a small proportion of total Italian borrowing. Banks are among the most prolific of the Italian issuers in the capital markets, excluding the republic itself. Those with large retail networks sell a lot of retail targeted paper through their branches at very attractive rates.

There have been few issues by these banks in the international market because they can achieve sub-Libor funding domestically. Cariplo, however, bucked the trend last July with a three tranche euro-tributary transaction.

Cariplo, the largest savings bank in the world and a regular issuer in the domestic markets of bonds targeted at its own customers, felt it was important to diversify its investor base in the run-up to Emu.

As investors move their money into equities and funds, issuing retail targeted transactions is no longer a viable borrowing strategy - according to Rosella Maronati, an official in debt origination at Cariplo.

"Banks are having to find new ways to fund themselves. Until now they could get money at substantial sub-Libor levels. Now that demand is decreasing for these products the banks will have to look at other ways of financing themselves. They will have to start looking at the international capital markets."

The issue for Cariplo did not reach the bank's usual funding targets. But, says Maronati, it had great strategic significance. "We gave something more than our usual targets because we understand that our future is in the international capital markets."

However, other market participants believe that banks will continue to be able to issue senior debt at sub-Libor levels. "Banks have better funding opportunities in Italy, where they can get good sub-Libor funding and the introduction of the euro will not change that fact," says Nuti of Credito Italiano.

"If they do tap the international markets it is for publicity reasons. The bigger banks might do it because they want to complement their domestic funding but it will always be cheaper for them to sell their paper to Italian retail."

Some regional banks have also made a move towards internationalising their funding. Banca Popolare dell'Emilia Romagna has already made its international markets debut after setting up a Euro-MTN programme last June.

Banca Popolare di Verona has also secured international ratings, set up a Euro-CP programme and is said to be mulling the possibility of establishing a Euro-MTN facility. Other banks have also sought international ratings.

Bankers see room for considerable growth in the market for subordinated bank debt. Banca Ambroveneto, which recently merged with Cariplo to form the Italy's second largest bank group behind San Paolo, has already twice issued upper tier two debt.

The bank has tapped the US dollar market, launching a $500m 10 year issue at a spread of Libor plus 95bp in a deal lead managed Barclays Capital and UBS - which offered investors their first chance to buy an upper tier two asset from an Italian bank.

Just last week, Ambroveneto launched a Lit600bn deal at Libor plus 62.5bp. Like the US dollar issue, the lira deal was also increased on the back of strong demand from investors.

  • 01 Jun 1998

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 24 Oct 2016
1 JPMorgan 317,793.98 1355 8.72%
2 Citi 301,114.13 1092 8.26%
3 Barclays 259,580.63 846 7.12%
4 Bank of America Merrill Lynch 258,842.43 934 7.10%
5 HSBC 224,273.23 905 6.15%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 25 Oct 2016
1 JPMorgan 32,854.00 58 6.73%
2 BNP Paribas 31,678.29 142 6.49%
3 UniCredit 31,604.22 138 6.47%
4 HSBC 25,798.87 114 5.29%
5 ING 21,769.65 121 4.46%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 25 Oct 2016
1 JPMorgan 14,633.71 80 10.23%
2 Goldman Sachs 11,731.14 63 8.20%
3 Morgan Stanley 9,435.23 48 6.60%
4 Bank of America Merrill Lynch 9,229.95 42 6.45%
5 UBS 8,781.68 42 6.14%