Turbulence clouds market as Telecom Italia sells 50yr
Volatility returned to the world's bond markets this week as a sharp rise in oil prices sparked renewed inflation fears in the US and Treasuries sold off, pushing the 10 year yield up through the 4.5% level and taking swap spreads and credit spreads wider with it.
Issuance continued at a moderate pace in the US high grade corporate bond market, where investors largely disregarded the volatility and came in keenly for a range of deals, pushing spreads for the sector tighter by 1bp.
In Europe and Asia, the Treasury sell-off, taking the 10 year yield out of its six month range of 4.0%-4.4%, unsettled markets. Bonds of all kinds widened by several basis points as investors began to fear a rate rise in the euro zone.
Into the thick of this hubbub on Tuesday came a groundbreaking deal by Telecom Italia — a Eu850m issue that was the first substantial 50 year corporate bond in euros.
The deal was inspired by the triumphant Eu6bn 50 year OAT a fortnight ago, which opened up a new tract of the euro yield curve to bond issuance.
But the troubled market this week clouded Telecom Italia's reception and made it hard to judge the outcome of the exercise. Sole lead manager Deutsche Bank pronounced it a success, but the deal drew widespread criticism from rival banks.
"Telecom Italia has opened the 50 year part of the curve for corporates and has done so successfully, with a Eu850m offering supported with a book of Eu1.7bn," said Francois Bleines, head of corporate bond syndicate at Deutsche Bank in London. "The increase in asset reallocation among pension funds and insurance companies, new accounting rules and the solvency ratio calculation on both asset and liabilities means there was strong appetite from real money accounts."
Investors placed Eu1.7bn of orders, enabling Deutsche Bank to increase the bond from Eu500m to Eu850m.
The Baa2/BBB+/A- rated bond was priced at 98bp over mid-swaps, against guidance of 95bp-100bp, reflecting the softer tone to the market, which was apparent on Tuesday morning.
However, the groundbreaking transaction was marred by a poor secondary market performance. The 2055s closed on Thursday 10bp wider than their launch spread, as the market continued to fall.
The transaction came at 106.4bp over the Bund and closed on Thursday at 116bp/114bp.
Bleines insisted the widening in the new 50 year bond was in line with the market, citing France Télécom's 2033s, which widened from 69bp to 78bp over Bunds; the Telecom Italia 2033s, marked 7bp wider; and the GM 2033s, which had moved from 456bp over Bunds on Tuesday to 466bp on Thursday.
Provoking the problems?
But Telecom Italia's deal arguably provoked some of the market movements this week, as well as being subjected to them.
Several market participants suggested that the very fact that a Baa2/BBB+/A- rated company could price 50 year debt at less than 100bp over mid-swaps had served as a wake-up call to investors that spreads had tightened too far.
The corporate bond market has rallied strongly since the start of the year — the iBoxx cash index closed at Bunds plus 43.04bp at the end of February, 9bp tighter than the previous month. This is a remarkable gain of around 18% in just two months, compared to the 15% index tightening over the whole of last year.
Many welcomed the volatility as a correction to an overbought market, which one syndicate official said was at ridiculous levels.
New issues took the brunt of the widening pressure — bonds from Telecom Italia and Finmeccanica, the Italian defence company, slipped in the aftermarket while French cement maker Lafarge printed its bond at the wide end of price talk.
One syndicate official pointed out that new issues are the worst hit when bonds are being shorted, as it is easier for banks to short new issues before the settlement date. He said the volatility was a nice reminder that the market does not only go one way.
Bankers said a lot of market players had been shorting the Telecom Italia deal.
Investors in the UK and Germany took 70% of the bonds, with good orders from the Benelux, Spain, Italy and France. Fund managers, insurance companies, pension funds and central banks took close to 70%, the leads said, suggesting that hedge funds and other trading accounts bought the rest.
The two main criticisms levelled at the Telecom Italia trade were the fact that it was led by Deutsche Bank alone and that it was increased from Eu500m to Eu850m.
"Firstly, having sole books on a 50 year deal is completely inappropriate," said one syndicate official. "In bringing a 50 year deal, there is a greater risk of volatility in secondary market performance, due to the higher participation of hedge funds at the long end. You'd want all the extra protection you can get, but with a sole bookrunner there is only one market making house."
The banker added that the transaction was "clearly too large", since at Eu850m it looked like Telecom Italia was "taking the maximum it can take out of the market, which you just shouldn't do on a 50 year trade. They should have printed Eu500m and tapped it."
The transaction from Telecom Italia comes just two weeks after France opened up the ultra-long maturity with a Eu6bn 50 year OAT that attracted over Eu19bn of orders.
Barclays Capital, BNP Paribas, Deutsche Bank and HSBC handled the groundbreaking transaction for Agence France Trésor. The remarkable strength of demand surprised even the deal's backers and allowed it to be priced at just 3bp over the 2035 OAT.
An official at Telecom Italia said that current market conditions were conducive to long dated issuance.
Locking in cheap funding
"It is an extremely good market moment, with interest rates and credit spreads at very tight levels," he said. "The paramount objective of the transaction was to lock in these interest rate levels for the longest possible time. We felt a pick-up of between 15bp and 20bp from 30 to 50 years was satisfactory for investors and a sensible level for the additional credit exposure.
"We are absolutely satisfied with the pricing. To get 50 year financing at below 5.3% for a triple-B rated company — you can only be happy."
Bleines said France's pioneering transaction had inspired Telecom Italia's deal. "We took the decision to bring the deal to the market on Monday, as after bringing France's new 50 year OAT a couple of weeks ago, we had calls from investors asking for similar maturity credit assets."
As Bleines pointed out, there have been 50 and 100 year bonds (and even longer ones) in the US and sterling markets, but very few and not for about 10 years.
"For example, IBM brought a 100 year in 1996, while British Gas priced a £200m 50 year in 1994," Bleines said. "but there are few of them, they are smaller in size and they were issued in different currencies. There are very few bonds like this one — definitely not of this magnitude."
Telecom Italia is credited with having established the 30 year sector of the euro corporate bond market when it launched a Eu400m 30 year bond in early January 2003, which was later increased by a further Eu400m due to investor demand.
The issue sparked a wave of 30 year issuance from the telecom and utility sector that year, but corporate issuers stayed out of the long end of the euro curve last year, and the longest issue was for 20 years.
The first spate of 30 year deals in January and early February 2003 did not perform well in the secondary market.
Issues by France Télécom, RWE, Electricité de France, Deutsche Telekom and Telefónica all suffered.
For example, RWE priced its Eu750m deal at 115bp over the Bund and it traded in to 105bp over before widening to 145bp over in the weeks after launch. Similarly, Electricité de France's Eu850m deal came at 97bp over the Bund and traded as wide as 120bp over.
However, spreads came in over the course of the year to produce some of the best performing bonds of 2003.