The UKs investment grade corporate borrowers have long been known for being selective about their funding options and sensitive on pricing, to the point of being fussy. But although they are only interested in the markets with the most preferential issuance conditions, in the past year they have found their funding options becoming ever broader, as investor demand for their paper has swollen.
"UK blue chip companies have always had the capacity to raise debt in different tenors, currencies and formats," says Philippe Bradshaw, head of European corporate syndicate at Royal Bank of Scotland in London. "But when you have markets that are risk-off, and have been for the last 2-1/2 years, the opportunities have increased even more. Blue chips are seen as a safe haven, and when investors have limited options about where to put their cash, its an obvious choice."
This demand means the bond market is unusually attractive for the UKs strong corporate credits, and even for those with weaker or cross-over ratings. Rates are low and spreads are tight. Like those of Germany, the Netherlands and the Nordic region, UK companies are seen as a safe haven for investors, with a degree of protection from the eurozone crisis. They have been taking advantage of this to price bonds at aggressive funding costs, compared to their own past levels and to some of their European peers.
"A UK corporate borrowers position in Europe is a good one right now," says Rob Ritchie, head of corporate debt capital markets in western Europe at Goldman Sachs in London. "In some regions, particularly in southern Europe, companies have had to go beyond the capital markets and their banks to get their funding done. In some cases theyve had to turn to non-traditional forms of financing against their assets to gain liquidity. Weve not really seen that problem in the UK, where ratings are still good, balance sheets are strong and borrowers have reasonable liquidity."
The result has been credit spreads grinding tighter, to the point where Farouk Ramzan, head of corporate debt capital markets at Lloyds Bank in London, says they are "challenging the tight levels last seen in the halcyon days of 2006 and 2007".
The tightening has become acute during the keen surge of corporate bond buying in September. "On average," Ramzan says, "the new issue premium for low beta, defensive issuers is between zero and 5bp compared to their outstanding curve. This reflects the technical imbalance between supply and demand in the primary market given that corporate bonds are the asset class of choice at the moment and that secondary market liquidity is really thin."
Demand is especially strong in the US market, which offers the best visibility about the size of funding available at the most cost-effective pricing.
"This year, the dollar market has been very buoyant and UK blue chips are really taking advantage of it," says Ramzan. "You have low execution risk, theres a lot of demand, pricing is good and swap markets are reasonably benign, although this can shift. Theres a lot of investor interest and money there, so its not surprising that theres a lot of activity in the dollar market."
Investors in the US are particularly open to UK borrowers, recognising their status as safe haven European names.
"The Yankee market has remained difficult for peripheral borrowers over the last 18 months, however UK names have had better access," says Barry Donlon, head of corporate syndicate at UBS in London. "This is down to the UK having an independent currency and being perceived as less heavily correlated to the volatility in the eurozone. US investors buying UK blue chip paper can add exposure to Europe without feeling vulnerable."
In May alone, GlaxoSmithKline raised $5bn, Diageo $2.5bn, BP $3bn, BAT $2bn and Pearson $500m.
And at the end of July, Unilever, the UK-Dutch food and household products group, raised $450m of three year bonds and $550m of five years at record low coupons of 0.45% and 0.85%.
Although some bankers are worried about whether the US market will be able to continue to take up the slack, should the eurozone crisis worsen in the coming months, for the moment there is capacity for borrowers to issue jumbo deals. By doing so, while remaining an infrequent issuer, UK borrowers can preserve their rarity value, yet create a liquid, performing benchmark that can be used as a reference for pricing future deals.
"Rather than systematically going to various markets, some borrowers are just executing big old dollar deals," says Ramzan. "The days of the jumbo dollar deal are not back, but if event risk is relatively low in dollars, execution risk is low, pricing is good why mess around? If you get a big dollar deal done you can take a large piece of financing off the table and then look to see if you can tactically arbitrage the other markets over the remainder of the year."
Investors get flexible
This is not to say that UK borrowers have moved away from the sterling and euro markets. Their options are growing here, too, as investors, hungry
for paper, become ever more accommodating.
Typically, issuers go to the euro market for tenors of one to 10 years, while at longer maturities the sterling market beats all for depth and pricing.
But this pattern is becoming more fluid. The scarcity of yield is tempting European investors into longer maturities although UK issuers have not explored this territory yet. And in sterling, as Ritchie explains: "With exceptionally strong retail flows into credit funds theres a short term bid developing, allowing issuers to fund in sterling at the shorter maturities." The UK retail funds bid has been augmented by European investors moving money into sterling this year as a diversification from the troubled euro.
"Meanwhile, at the other end of the market," Ritchie adds, "pension funds and insurers are still looking for yield and are looking for very long dated bonds."
The keenness of that bid was evident at the end of August, when Centrica, the gas, oil and electricity group, sold a £500m 32 year bond that attracted a book of around £1.2bn and was priced with a minimal new issue premium with a 4.25% coupon 0.125% tighter than the coupon on its £750m 17 year bond in March.
"Investors cant find enough supply of straight, unsecured bonds and are showing more flexibility now than a few months ago," says Bradshaw. "Its pushing the investors at big institutions to be more flexible, to look at alternatives to plain vanilla bonds."
One option is hybrid capital. This summer BG Energy and SSE, the former Scottish and Southern Energy, raised £2.2bn between them in dollars sold to Asian retail investors euros and sterling.
UK blue chip borrowers are also interested in diversifying their funding outside these three core currencies. National Grid sold a rare Maple bond of C$750m in September.
"There have been some Unilever and others that have gone to China to fund in renmimbi, among other currencies," says Ritchie. "But the real question for UK blue chips is why would they go to the effort of diversifying with foreign currency funding, when its likely that its as attractive or more attractive in the dollar or sterling markets, which are so liquid right now."
While the financial crisis has put a premium on funding diversity, many of the top UK borrowers had already explored other markets before that.
"Most of the UK corporates are not purely UK names," says Donlon. "Most are geographically diversified from a revenue perspective and because of that, are more likely to have issued in a variety of currencies. Its very hard as a borrower to establish yourself in a market during a period of volatility. But these UK blue chips are well established, they have a good following and the investor base has stuck with them."
The issuer that exemplifies this approach is BP. The oil groups debt portfolio reflects the multitude of international operations and assets it has to finance. This year, it has borrowed in the euro, US and Canadian dollar markets, and in August, finding another diversification opportunity, it issued its debut Australian dollar bond.
"BP is a good example of a company that looks around by jurisdiction to establish the best market and currency from a price perspective," says Donlon of UBS, which led the deal with ANZ. "This summer, it turned out to be Australian dollars and Eurodollars, and by taking this approach they have sourced extremely cost-effective funding."
That kind of approach to funding relies on being flexible having leeway in your plans and the right documentation to be able to pounce opportunistically when a chance arises.
"Centrica had no immediate need for funds, but just felt that the conditions were right to issue," says Ritchie at Goldman Sachs, which led the 32 year sterling deal with Credit Suisse, Lloyds, Mitsubishi UFJ Securities, RBC Capital Markets and UBS. "We hadnt originally planned for an August pricing date as its usually so quiet, but we brought it forward as the market was so supportive."
The enthusiasm of that backing from the markets has ebbed and flowed at times, as investors fears about Europes economy have fluctuated and they have repositioned their credit holdings. But in the main, UK corporates have been able to rely on the bond market as they reduce their loan funding.
"Theres been a general deleveraging of corporates, and thats allowed borrowers to be more selective going forward about which markets they want to approach," says Simon Allocca, head of loan markets at Lloyds Bank Wholesale Banking & Markets in London. "This deleveraging has been by way of loans rather than bonds and it means theyre going to be in a better shape going into the future."
The variety of borrowing options open to UK blue chips is probably broader than ever allowing them to feel confident about the future security of their funding."Its no secret that well be in a different world in four or five years time," says Bradshaw. "The balance between loans and bonds is shifting towards bonds. It is comforting for issuers going through this process to know that the bond markets are very co-operative for corporates, that theyre not getting stuck into a corner where they will have to pay up to attract investors. Its a very positive outlook."