Corporate bonds have become the asset class of choice for European fixed income investors or at least, the one that is causing them fewest sleepless nights.
The usual tiering in which corporate debt is seen as the riskiest of the three main sectors, above banks and governments, was upset by the 2008 credit crisis, but as 2012 begins, it is more out of kilter than ever.
In mid-December the Markit iTraxx Europe Main index, which tracks liquid investment grade corporate credit default swap spreads, stood at 187bp. The equivalent index for senior bank debt was 312bp, while the SovX Western Europe gauge of sovereign spreads was 367bp. Care-worn corporate treasurers should be grateful for their lot at least they arent running funding for a bank or government.
Further reassurance can be found in investment banks credit strategy advice for 2012. Barclays Capital, BNP Paribas, Deutsche Bank and Société Générale all encourage investors to buy European investment grade corporate credit. Barclays thinks it could produce a total return of 5.5%-6% in 2012.
"There will be a technical bias in favour of corporate bonds," predicts Nick Bamber, head of investment grade corporate bond origination at Royal Bank of Scotland in London. "Its the one place you want to put your money to work." And investors have plenty of it, he adds. "Its noticeable in the recent deals there were very few switches most investors are just buying for cash. Some of them have billions on the sidelines."
Yet for treasurers facing a new years funding activity, things are not easy. The European corporate bond market is in a state of stress as reflected in credit spreads. Corporate spreads over Bunds or swaps may be half those of many sovereigns and banks, but in many cases they are still double what they were last spring.
"It is a much more difficult economic outlook," says Henning Lenz, head of corporate credit at WestLB Mellon Asset Management in Düsseldorf. "The topics remain the same, but whereas a year ago we were talking about Greece and Ireland, now we are talking about France, Italy and Germany."
Unlike many recessions, the 2008 crash did not stem from overcapacity in the industrial or services sectors. Continued growth in emerging markets, aggressive cost-cutting and ultra-low interest rates have saved many corporate balance sheets from severe damage. Fatalities have been concentrated in vulnerable, consumer-facing sectors like retail that are suffering from technological change, and among overleveraged companies.
Three years of belt-tightening have left the large cap corporate sector unusually fit, with lower debt and higher cash balances than usual. Hence, their bonds are in demand.
Companies have not caught the sickness of banks and governments, but they are not immune. "We are moving to the core of the problem the future of the euro," says Lenz. "In an environment where there are fears of the cooling off of Asia and Latin America, probably a soft recession in Europe and a softening, though not recession, in the US."
Many companies are still managing to increase their profits, but there are doubts that this can continue when even the future political map of Europe is hazy, and many governments are cutting spending.
Like many in the financial markets, Richard Bartlett, head of corporate debt capital markets and risk solutions at RBS in London, believes the EU summit of December 8 was a step in the right direction. All the euro members agreed to a fiscal responsibility pact and more financial support for struggling countries. But he adds: "The markets view is that its not fundamentally solved the economic challenges."
The corporate sectors fortunes, therefore, will remain governed in 2012 more than anything by what is agreed between EU leaders and the effects of these policies.Crisis returns
The dark clouds swirling over Europes future swept into the corporate bond market quite suddenly, in the last week of May.
Since January 10, the iTraxx Europe index had closed between 95bp-105bp, and for a month it had been below 100bp.
The third week in May was exceptionally busy for corporate bond issuance, with a dozen deals priced in euros totalling 5.8bn and three in sterling for £1.6bn. Borrowers including retailers Casino of France and Co-operative Group of the UK were eager to catch up on a slow year for deals so far. Many issuers had held back, put off by unrest in north Africa, Japans tsunami and nuclear disaster in March and even the extra UK holidays in April for Prince Williams wedding.
Demand was rampant. Issue after issue came at the tight end of lowered spread talk, with book sizes such as 2.5bn for Telecom Italias 750m seven year issue and 1.5bn for Czech power company ČEZs 500m five year.
"I have never printed a deal every day of the week before," said a London syndicate manager. "The market is deluged with issues its the first time all year."
It was almost the last. On May 19 the iTraxx Europe reached 100bp, but this time it was not to return. That weekend, Fitch downgraded Greece three notches to B+, regional elections weakened the Spanish government and Standard & Poors put Italys A+ rating on negative outlook.
The second, more alarming phase of the European sovereign debt crisis had begun. By mid-August, the iTraxx had broken through 150bp, and it has never since closed below that.
For investors, the spread widening ate up some of their returns in 2011. Lenz calculates the total return in 2011 on non-financial corporate bonds at 3% better than bank bonds, which lost 1.5%, but far from juicy.
A good part of that return came from the rally in Treasuries, Bunds and Gilts, which helped issuers, too. Even when the iTraxx was topping 200bp in late September and late November, well rated companies could get long term funding at near record low fixed rates. That is a big reason why, despite the market stress, issuance remained healthy for much of the second half of 2011, so that the years total of 213bn exactly matched the much sunnier previous year.
While corporate bond sales in the second half were 26% lower than in the first six months, the depression in market activity really lasted from June to August. The average monthly issuance from September to mid-December, of 21bn, was the same as from January to May.
|Italy and Spain: how brave will investors be?|
|The big question for Italian and Spanish borrowers is whether issuers other than the very top tier companies will be able to sell bonds in 2012, at a price, or not.
From June onwards, there were only two Italian high yield issues, by Fiat and glassmaker Bormioli Rocco, and one Spanish deal, by cable TV company Ono. All three were in July.
Almost all the other Italian and Spanish issuance came from national champions in energy or telecoms. These companies are widely trusted by investors, as having robust, stable business models and in many cases much of their cashflows originating outside the home country. Enel, for example, is active in 40 countries. Even a sovereign default need not bring them down though euro exit, still a remote risk, might.
Italian electricity producer Enel issued in early July, as did Amadeus, a Spanish-based airline ticketing systems company with little exposure to the domestic economy.
Then there was nothing until mid-October, when Enel, Telecom Italia, Telefónica and Spanish power group Iberdrola all issued in the space of a week, before the window closed again.
Only Repsol an oil company that had not issued since 2007 was able to break the silence at the end of the year.
This pattern strongly suggests that even for the super-blue chips, issuance would have been difficult at other times. "The market has not really been closed, but in some weeks or moments, it would have been quite unpopular to try and tap the market. Its better not to," says Alessandro Canta, head of group finance at Enel in Rome. "Its a question of pricing. If you add 100bp-150bp to the spread there would be some high yield investors willing to buy but it would probably send a misleading message. People would ask, why is a company that doesnt need the money issuing at a very high premium?"
The evidence of 2011 suggests that the elite of corporate Italy and Spain will get all the market access they need in 2012. It may not be continuous, but they do not need that, and they have many other sources of funds.
No deals give no guidance
How will smaller or lower rated companies fare? Farmafactoring, for example, is an Italian factoring company now owned by Apax Partners that collects debts owed to drug companies by Italian regions. Rated BBB, it roadshowed for a bond in June but never issued.
Just because lesser Italian and Spanish issuers have not come to the market, does not mean they could not. "Is there a deal for them? It depends," says Nick Bamber, head of investment grade corporate bond origination at RBS. "For some, there may well not be. Those with 70% or 100% domestic cashflows do struggle now. If they are willing to pay 7% or 8% they might appeal to high yield investors. But so far they have not done that theyve just drawn on their bank lines."
Canta believes that for smaller Italian companies, new to the market, issuing in recent months would have been impossible. "It would have been hard for investors to make a career trade and take a bet on a new Italian company at this stage in markets," he says.
Outside the world of leveraged finance, the kind of Italian and Spanish companies that could consider bond issues are likely to be the better names on the client lists of their domestic banks. They are unlikely, therefore, to face financial distress if they cannot issue bonds.But rather than rely too heavily on the banks, at least some of these businesses are likely to try coming to the market in 2012. Such deals could prove challenging but rewarding for both issuer and investors if they come off.
Learning a new rulebook
Yet since the end of May, selling a corporate bond has been a slippery business. As European blue chip stocks lost a third of their value between the end of April and mid-September, credit investors were understandably jumpy.
Despite the long term nature of corporate bond investment, many European fund managers understandably get nervous about buying new issues that might suddenly trade wider in the secondary market. In present market conditions, the factors that govern aftermarket performance rarely have anything to do with the bond in question but are pieces of political or macroeconomic news that sway risk appetite around the globe.
That has made it difficult for companies to borrow at times, forcing them to search for windows when the market is open sometimes for just a day or two, or even a few hours.
"We have got used to living with volatility," says Alessandro Canta, head of group finance at the Italian energy company Enel in Rome. "Since 2008 we decided to take a different approach to the market being very well prepared in advance. Last year was the proof of our approach."
Enel was the king of the windows in 2011 a fact reflected in its two large dual-tranche euro issues being voted first and second Euro Investment Grade Corporate Deals of the Year in EuroWeeks poll (see Polls section).
Both Enels 1.75bn six and 10 year issue in July and its 2.25bn of four and seven years in October appeared presciently timed. Each deal followed weeks when investors seemed reluctant to buy Italian corporate paper.
Enels window in July appeared after the Greek parliament approved an austerity package, sparking a rally in stocks and credit. The very evening after the sale, Moodys downgraded Portugal by four notches, souring the market so badly that the next day, Autoroutes du Sud de la France, an unimpeachable French toll road company, had to pull a deal after launch.
In the past, as Canta puts it, "opportunistic funding was a bad word", implying borrowers who issued as it pleased them, showing little concern for investors. Now, this same attribute, though with a kinder meaning, has become the goal for many regular issuers.
"For 2012, as for 2011, the ideal thing is to have an opportunistic approach," says Sergio Val, head of corporate finance and treasury at GDF Suez, the French gas and electricity group, when asked his advice for other treasurers. "Its difficult to see market conditions normalising, at least in the short term."
What Canta and Val mean is that companies must seek the freedom and agility to tap the market when opportunities arise, rather than being forced by financial need or poor planning to borrow at an unfavourable moment.
While many picked good moments and raised funds in 2011, some slipped and fell. In the UK, for example, Anglian Water had to pull a deal in July when markets wobbled, while airports group BAA did it twice in the autumn.
|A ticket to ride: the growth |
of new issue premiums
|Even when windows are open for companies to issue bonds, paying a new issue premium has become the norm.
"In the first four or five months of 2011 you wouldnt even talk about new issue premiums," says Marco Baldini, head of corporate bond syndicate at Barclays Capital in London. "You started the talk 5bp above the secondary curve and hoped to price in line with it."
Now, investors expect to end up with a concession in their pockets, as insurance against what a blustery secondary market might do to them. The volatility of spreads has worsened since May, as banks have cut back on trading to avoid taking losses and use their capital more sparingly. The result is exceptionally poor liquidity.
The amount of premium issuers might have to pay is now another factor they have to weigh up when deciding when to come to market. Hardly any issuer of a benchmark euro or sterling deal since September has paid less than a 15bp concession, with 20bp-45bp being common.When Enel paid 35bp in July it was considered generous. By October, when the company came back for 2.25bn, bankers estimated the premiums at 50bp-80bp for the four year tranche and 68bp-90bp for the seven year. Again, Enel was happy to pay the going rate.
Who goes there?
The tense corporate bond market atmosphere is not just about timing, however. It is also about who is asking for money.
From being open to almost all comers even the Greek telecom company OTE found 1.8bn of demand for its 500m three year bond in April the market is now highly selective.
"The market for [peripheral] countries is closed nobody wants to be invested," says Lenz at WestLB Mellon. Others insist southern European companies can still borrow. But it is clear investors have become much more choosy (see box on page 139).
The corporate bond market is now split into four streams. Solidly investment grade companies in northern or core Europe are favoured by investors, and can issue as long as they pick a stable day and pay a decent new issue premium.
French investment grade borrowers form a second category. Their dominance of issuance from September to December 2011 was remarkable a sign both of strength and of weakness.
In September, 10 French borrowers produced 84% of the 7.7bn of European corporate deals in euros. After a breather in October, when Electricité de Frances £1.25bn 30 year deal at a 5.696% yield was the highlight, French firms supplied 32% of all European issuance in November and December, including all the benchmark euro deals for a fortnight.
Yann Passeron, head of capital markets at RCI Banque, Renaults finance arm, suggests two reasons for the near-stampede of 26 French borrowers in the autumn: "The volatility of the market they dont know if they can issue in 2012 and the difficulties of the continental banks. They are worried the banks wont be able to lend as much."
France is still part of the strong core of the Eurozone. But it appears the most at risk of being infected with the sudden loss of investor confidence that has struck Italy and Spain since the summer.
Lenz at WestLB Mellon, says his firm will still buy French deals but does not want to increase its exposure to the country, so tends to switch out of weaker French names into stronger or more attractively priced new issues. Thus French companies are still able to borrow, but have strong reasons to fear losing that ability a keen motivation to issue.
Bankers say French borrowers have had to pay an extra premium recently, due to the spate of issuance and the whiff of sovereign distress. If the pressure on French sovereign yields continues to ease and French corporate issuance slows, these borrowers could rejoin the first category.
The third group is investment grade companies in Italy and Spain and high yield issuers. Here, only the very strongest companies in each category have issued public bonds since the summer, and then only at carefully chosen moments (see box on page 139).
The European high yield market shrivelled to just 19 deals in the last five months of 2011, from 13 companies. Of the 4.5bn total, a mere 1.7bn was placed in euros and none in sterling. Worried about an economic downturn, investors went risk-off and shut their books to all but a tiny few, better rated issuers (see high yield chapters).
The fourth group are shut out of the mainstream bond market. This includes any company in Greece and probably in Portugal and Ireland.
Market participants agree that the stressed characteristics of the corporate bond market since June will persist in 2012: an intermittent market of windows; new issue premiums, varying by day and issuer (see box on page 140); and investors being very careful what kind of issuer they let in the door.
|No maturity wall|
|In any bond market there can be concerns that a refinancing wall may build up. Large issuance such as the European corporate market produced in 2009 can create mountains of debt that need to be repaid in future years, straining the markets capacity.
Analysing the markets maturity structure, however, and recent issuance patterns, suggests there is no such problem for European companies, in the aggregate.The lowest amount issued in all currencies in any of the last six years was 168bn in 2007, and that is likely to have been due to issuers holding back rather than investor reluctance. In the more stressed year of 2008, investors bought 185bn of paper, and in 2009, an astounding 429bn. The highest amount needing to be refinanced in any coming year is 213bn in 2014 a total that is unlikely to rise much now, as issuance of two year bonds is rare. That sum is equal to the total deal output in each of 2010 and 2011 further evidence that investors will be able to come up with the money.Moreover, net corporate bond issuance has been over 50bn every year since 2006, showing that investors are allocating fresh money to the asset class each year, as well as ploughing back what they reap from redemptions.Finally, these figures do not show the benefits of liability management. European investment grade companies bought back 11.5bn of bonds in 2011, according to RBS, spreading out their maturities and often reducing interest costs.
Big changes needed
Where observers disagree is whether conditions are likely to get better or worse. Lenz at WestLB Mellon hopes there will be a solution to the euro crisis in the first half of 2012, or even the first quarter. But he believes that will require big policy changes. "We need unlimited financing for governments from the ECB, as it is doing for banks," he says. Agreeing that European Central Bank president Mario Draghi has ruled that out, Lenz adds: "Maybe prices need to go down more until then politicians will hesitate to bring a comprehensive solution."
Thus Lenz hopes the second half of 2012 will bring a recovery in sentiment and GDP, after "a couple of quarters of negative growth".
Bartlett at RBS sees it the other way round. He says of corporate issuance: "The first quarter will be very active, the first half more active than the second."
Like Lenz, Bartlett believes the EU has not yet cracked the euro conundrum. But he argues that what was agreed in December could provide enough firepower to keep Italy solvent for most of 2012. With the problem deferred, he predicts that markets will be receptive to corporate issuance, though confidence might fray.
Like estate agents, bankers always have a tendency to urge their clients to do transactions as soon as possible. But this time, it seems, they really mean it.
"If I was a corporate treasurer," mused Håkan Wohlin, head of global debt origination at Deutsche Bank, at a Euromoney conference in November, "I would probably come to the market on January 5 and do all my funding for the year."
The longer issuers wait, the higher the risk that conditions worsen and they regret it a mistake that Marco Baldini, head of corporate bond syndicate at Barclays Capital in London, says many companies made in 2011.
Equally, if there is a marked improvement in the EU outlook, banks and government agencies have a vast amount of pent-up funding to do and corporate borrowers could get lost in the tide.
One way or the other, many market participants believe 2012 will be as busy as 2011, if not more so. "There are very deep rooted issues to be decided in Europe," says Baldini. "We will go at times to the brink, but I am hopeful that we will get there. Unfortunately, the only thing that will please the markets is the bazooka. But is it realistic? I doubt it."With that in mind, and conscious of the fragility of the banking system, many companies will accept conditions as they are and strive to raise money when they can, even if the spread or cost of funds is nothing to boast about. There is even an outside chance that, as in 2009, stress could yield a bumper crop of deals.