Turbulent markets, challenged banks – companies learn to navigate a new world

To judge by absolute funding costs, many blue chip companies have never had it so good. Interest rates are so low that even after two months of spread widening, they can raise long term debt at remarkably low levels.

  • 15 Sep 2011
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Even in the loan market, firms are still getting very tight margins. Debt raising is not a pressing concern, anyway, as many firms have built up large cash cushions and prefinanced their redemptions.

But it does not feel an easy time to be a corporate treasurer. Since the financial crisis began, banks have been under pressure, and it gives companies no satisfaction that their debt now trades inside bank paper.

Realising that banks carry risk means thinking much more carefully about where to place cash and which liquidity providers can be relied on – for many firms, a new kind of risk management.

Debt markets, too, are not as reliable as they were in the boom years. Though good companies can issue bonds in almost any market conditions, there are many days and weeks when investors do not want to play, and need to be tempted with fat new issue premiums, which companies may not want to pay. Secondary liquidity has suffered, and opinions vary as to the cause.

As financial regulation begins to tighten in response to the crisis, banks may also become more selective in what they offer clients. Relationships between banks and companies remain central to corporate finance, but the give and take involved are changing.

EuroWeek brought together five treasurers of leading companies with five corporate bankers and a representative of MTS Markets for a roundtable discussion in London on August 31.

Participants in the roundtable were:

Markus Unternährer, head capital markets bank relationship, Holcim

Jon Hay, EuroWeek (moderator)

Sergio Val, corporate director of financing and treasury, GDF Suez

Hugh Carter, head of credit syndicate, Commerzbank

Håkan Wohlin, global head of debt origination, CMTS, Deutsche Bank

Anthony Bryson, head of corporate debt capital markets, Europe, BNP Paribas

Olivier Klaric, group treasurer, Sanofi

Pascal Bay, head of corporate debt capital markets, EMEA, Bank of America Merrill Lynch

Rick Martin, group director, treasury and investor relations, Virgin Media

Matthew Palmer, director, debt capital markets, HSBC

Richard Veffer, group treasurer, Koninklijke KPN

Fabrizio Testa, head of product development, MTS Markets

Part 1: Corporate bond markets today: bright or bleak?

EUROWEEK: Why is there so much turmoil in the market and when is it going to end?

Anthony Bryson, BNP Paribas:
There’s been a shift from liquidity risk, which caused Lehman Brothers to fail, to counterparty risk, to credit risk. We have seen geopolitical risk recently, which is still ongoing in northern Africa, and risk based on nature in Japan.

What I am waiting for is when will investors start looking through the sovereign and bank risk and see the value in corporates, which have business models that are well understandable, and start buying corporates in euros.

August was the third busiest month this year in dollars for corporate credit, but it has been disappointing in euros. Even a decade after the introduction of the euro we are still not seeing the credit sophistication and depth of the US.

Fabrizio Testa, MTS Markets: The intervention of the ECB has stabilised sovereign markets for the time being. Yesterday was the first auction from Italy after a month and although the coverage was not great, it went through quite smoothly so the market today was definitely better.

The risk moves somewhere else, wherever there is no protection from above. There is a lot of volatility and for our interdealer platform, which relies on two way, tradable prices from investment banks, it results in wider bid-offer spreads and lower turnover.

Håkan Wohlin, Deutsche Bank: It is clearly very positive for the market that the ECB is buying Italian and Spanish bonds.

However, so far this has not created a two way market. The buying thus far has created an artificial bid around 5%.

That’s all great but we don’t yet have a market, with a two way flow. You have no buyers other than the ECB at those levels. Until we have buyers we will have a very abnormal market.

Richard Veffer, KPN: I don’t know what’s going to happen, and that’s the problem. More people are admitting that they don’t know.

I am very focused on euro markets. Typically we fund in euros, although we also go to different markets. It seems as though everybody now is saying, "I don’t know, so we are going to wait."

Every now and then, there are windows where we think, "maybe we could issue", but they are getting shorter. From my point of view sometimes they are not even windows if you look at the conditions you get.

EUROWEEK: A bathroom window?

Veffer, KPN: Yes – and really fogged up after you have been in the shower.

I am a big believer in the euro because I see a lot of benefits, but I am starting to doubt whether this is a market you can really depend on. We are forced to look at alternative options.

In the Netherlands and Benelux I hear rumours about retail investors. Savers who get a deposit back don’t want to invest in euros any more – they go to Swiss francs or even the Nordic currencies.

That doesn’t help – if even at that level people don’t trust the euro any more. For the next three months we are probably safe, but I am worried about the longer term.

Matt Palmer, HSBC: The euro market has its own characteristics. Rather than defend the euro, we should be praising the US dollar market, for its ability to price risk and remain open over consistent periods.

It’s not just about whether investors have the conviction to put money to work. They undoubtedly have money in both Europe and the US, and at the moment they would rather have it invested in corporates, rather than financials and sovereigns.

But it’s also about whether issuers have the conviction to access the market, and feel the premiums payable in the market at the moment are right.

Participants in the US market have a more fixed rate focus. There’s a natural offset or compensator, which is that in a risk-off environment you typically get a lowering of Treasury yields, which can then attract borrowers.

In the euro market, both issuers and investors tend to take a more floating rate approach, which does engender more caution. There is often a mutual ‘stand back and wait’ approach, which is valid as well – you can’t criticise it.

But equally, when you look at the opportunities that corporates and investors have had in the dollar markets, both public and private, in August, you have to say that market is more resilient to external factors.

Rick Martin, Virgin Media: It feels like there might be a brief period of quiet in Europe. As long as the peripherals can continue to roll their short term debt, we might avoid anything as bad as 2008.

On the other hand, some of the prognostications of various countries about how their budget problems will be resolved are predicated on optimistic growth forecasts.

In an environment like that, for a serial issuer like us, optionality is the absolute key. We have a range of relationship banks, four of which are here today. We have tapped both the dollar and sterling markets. We have issued unsecured high yield bonds and senior secured, which enjoy an investment grade rating.

The key at a time like this is not to try and predict. Certainly one needs to be mindful and have a view on the future, but the key is to be able to play in a wide range of markets and credit spaces. When windows present, you can move quickly across a range of options.

Hugh Carter, Commerzbank: That’s very true. I don’t underestimate the events that took place in August but we need to remember what August is in Europe.

The backdrop was ghastly. The US political debate did not help. It wasn’t the downgrade, it was the debate. The European politics haven’t helped because it’s a consensus decision-making process and it can’t rely on just two people meeting in Berlin one day.

Matthew is right that the US markets, through long and deep experience, are able to invest in credit through the worst times. In Europe, there was no liquidity in the stock or bond markets. Investors and trading managers were unlikely to make rash decisions in August.

What we’re facing today is some form of retrenchment and reassessment of the volatility that took place. We’re advising our clients that this is probably an opportunity to look for value in the corporate bond markets.

Since many corporates do not need to borrow very much money for the rest of this year, and investors have cash to put to work, the supply may be not enough to fulfil their requirements if we start to get some stability.

Consequently, over the next weeks, we are probably going to have a better time. There are going to be points when markets close, through any number of events, but we shouldn’t think the whole thing is closed and we’re unable to see anything.

In the middle of August we all probably thought it was closed for at least two to three months. Now, we’ve got transactions being announced, even hybrid debt.

And in the bank space, which has been under the most pressure recently, covered bonds have been very active in the last week. Things change and you have to look at the good side.

Pascal Bay, Bank of America Merrill Lynch: Another big difference with the US market is critical mass. In the US you have more investment grade issuers than in Europe. There are 3,000-plus rated companies in the world, and 60% of them are American. So you have many more smaller companies accessing the market there and making the market lively – it’s not just the volume, which is twice that of the European markets.

Sergio Val, GDF Suez: Investors are back from their holidays. They are reassessing the risk and reward equation. In the middle of August we thought the markets would be closed for two or three months. Now things are starting to pick up.

Hopefully there will be new issues in the euro market and investors will start making some money on them. Premiums will reduce and we will see a normalisation of the market.

We have been very active in the last 12 months, doing a few very important issues for ourselves. We issued our first century bond in the euro market. We have been lengthening our maturities. We are fully liquid for the next five years and will have a very opportunistic approach.

Markus Unternährer, Holcim: I fully agree that it’s important to have access to a large number of markets. We have worked over the last few years to get this access in many markets.

We have been active in the European market for some time. We issued our first bond in the US market two years ago, but we are also active in more local markets like Australia, Thailand, Canada, Morocco, Argentina and Costa Rica, and are now working on a transaction in Mexico.

We can observe and monitor market conditions. They are different in each market and we choose the right location at the right time. There is still a lot of liquidity available in many of those local markets.

Val, GDF Suez: Local bond markets are a key component of our funding strategy. We tap the Swiss market, the Samurai market and also our different subsidiaries have a presence in the Brazilian market, the Chilean market and the Thai baht

Bryson, BNPP: One interesting effect of Basel III is that the cost of doing long-dated, uncollateralised cross-currency swaps is going to go up. That suggests there will be much more issuance in local currencies, not just driven by arbitrage but because the business actually needs those currencies.

EUROWEEK: And some of those markets have remained active when the core euro and sterling markets weren’t. Isn’t it strange that the corporate bond market is basically OK, issuers and investors want to do deals, but it’s like everybody is scared to go out on the dance floor and get together. Is this is the way it’s going to be from now on?

Bay, BAML: Will volatility continue to persist? Probably. The markets slightly underestimate the efforts made by the governments but still, there is a lot of headline risk.

The European markets have been a bit quiet but there is a very big difference between 2008 and today. Looking at the cash position of European corporates, most of them simply don’t need to access markets. A large portion of especially the top quality names, which have the luxury to access dollars, euros or whatever they want, don’t need to.

I am not pessimistic about issuance, as the cash position of investors is growing in Europe, even if we had some outflows from credit funds in August.

It is just a question of offer and demand, and what is the new issue concession. In the investment grade market, especially top quality names, I see no reason why the markets should not reopen very quickly.

Olivier Klaric, Sanofi: We will have abnormal markets for quite a while, with ups and downs. What happened in August is not an isolated phenomenon. It is a replica of something that started in 2007 and will last for quite long, I’m afraid.

It is fundamentally a tectonic change in the markets, both in geopolitical terms, and in terms of the corporate sector versus banking versus governments. There will be more crises like this one.

But there will be windows of opportunity. When real interest rates are going down, and maybe going to become negative as they are in Switzerland, even if you have a high spread due to volatility, or because your ratings are not that good, in absolute terms it is going to be free money.

Once treasurers have understood that, they will say, "OK, I am going to pay twice the spread I paid a year ago, but so what?" There is a question of pride, maybe: some people don’t want to look stupid because the next guy might get a 10bp better spread. But, all-in, their funding cost will be very reasonable. The market should resume on that basis.

Wohlin, Deutsche: In August we didn’t have a lot of flow. There was enormous repricing without a lot of action taking place. It was primarily UK accounts selling and Dutch, French and German accounts buying.

Now pension and insurance companies are sitting with a lot of cash. Mark-to-market buyers are waiting for some performance protection and hedge funds and retail are on the side. That would suggest a very good picture for more corporate issuance – quite bullish, at least technically.

What some are missing is that we will have reinvestment proceeds from the FIG and sovereign sectors in Europe of €30bn to €60bn a month, starting in September, for the rest of the year.

That creates a huge negative supply situation, which will speak quite positively for corporates if they need the money.

The new issue premium, which may be anywhere from 15bp to 50bp, depending on who you are and what country you reside in, may come in. So mechanically speaking, it will be a very good market in the next few months. We have seen a few names already and I don’t think corporates are afraid of issuing; they just don’t need the money.

On the downside, the biggest risk is not, for example, M&A risk – corporates have plenty of cash – but what Martin Wolf called "the Great Contraction". Nobody can really know yet what the outcome is, of this enormous slowdown in growth in the Western world, including Europe.

For companies that don’t rely on exports to emerging markets, what does that actually mean for credit quality over the next five years?

Bryson, BNPP: To put some meat on the bones I have a statistic. We’ve run a table of the top 50 European cash-rich corporates and in sum they have €310bn.

Wohlin, Deutsche: With all that cash, and with a favourable issuance environment, what opportunities present themselves? At Sanofi, you made an acquisition for which you hardly paid anything, at least for the borrowed money.

But you have to have confidence in the boardroom that what you are buying is going to produce some positive return on equity. How do you do that in the Great Contraction?

Martin, Virgin Media: A lot of companies are putting their cash to work in share repurchases – total volumes have spiked markedly. When the cost of debt is so cheap, and the cost of equity so high, it makes sense to take out the more expensive part of your capital structure if you can. That will be one place where cash goes.

Carter, Commerzbank: Corporates will continue to do what corporates do, and that is what was missing in this big volatility in August. Nobody focused on the fact that companies will carry on their normal daily business.

I come back to this point about the US. The US has decades of solid fixed income investment and is able to steer, through very rough waters, bond issuance when stocks are going down.

Europe has to go that way, particularly in the corporate bond market. That is what we may well be starting to see now, because corporate bond investors will say, "We are not talking about Greece with a top quality European corporate. We are talking about somebody that makes widgets, and he is still going to make widgets day in and day out."

The only point at which this changes is when there is a major downturn in the global economy, which is not something that happened in August alone. We got ourselves into a frightful knot during August, where people’s assessment became irrational because nobody wanted to commit to anything. You couldn’t take risks.

That stability we are looking for is probably lurking somewhere around the corner.

Bryson, BNPP: We bankers have all been travelling a lot, given the markets are quiet. One of the more challenging discussions we have in Europe is this sporty ambition of issuers to contain the new issue premium and not be the first issuer out there.

It’s true, when you have stable markets and you are the first to go, you probably pay too much premium. If you wait and be the fifth issuer you pay less.

But look at Enel in July. They had waited to issue for a long time, and then did a bond that was criticised by some for the new issue premium. Then afterwards the market shut.

BMW too said recently: "We opened and shut the markets." So with hindsight, the premium was worth paying.

In the US, of course you have sophisticated treasurers, investors and bankers on all sides and there’s a relative value discussion, but corporates are much more: "What’s the context of the market? I like the fixed rate. Go and get me the money." It’s a more rational dialogue.

Here it is: "Should I be the first or second? Should I wait?" Everybody is trying to second guess everything. That is why there still hasn’t been a corporate deal this week.

EUROWEEK: Can I ask the issuers, is the spread over swaps important to you because of the way you manage your treasury book, or is it because you think the investors care and you want to be the issuer that had a good spread at new issue?

Veffer, KPN: It is a little bit of both, but in Europe, sometimes issuers do focus too much on spread. If you look at what they really do with the bonds they issue, it is not much.

EUROWEEK: They keep it fixed?

Veffer, KPN: Exactly. So you can question why they are fixated with spreads.

But if you want to be a bit more active in managing your interest duration or risk, then yes, the spread you pay today is what you carry for the term of the bond. You can’t swap it away, you can’t do anything with it, so it is a relevant cost factor.

At the same time, are we obsessed by what investors think? Yes, to a certain extent. All my banks – and we have quite a few – seem to have the same message. They tell you investors think it is important.

You need to issue a bond that performs because you need investors the next time, especially if you are a frequent issuer.

At the same time, if you look at spreads and new issue premiums today, there is a role for investors and banks together to manage that away.

We, as issuers, never want to be the first because then we pay 5bp or 10bp extra. You also don’t want to be the tenth because then you are back to where the first was, if you’re not careful, or the window closes.

As an issuer, it is hard to break that cycle. It is the investors that want, demand or need the new issue premium. It is hard for me as an issuer to see how I can change something there, other than just waiting until some of my peers say, "Let’s bite the bullet and go."

Wohlin, Deutsche: Banks are funny institutions. At one end we advise you not to care so much about the spread and think fixed rate for bonds, and then when we lend you money the next week we really care about that spread.

Unternährer, Holcim: It has changed in the last years. Before the crisis started in ’07-’08 we were much more focused on spreads and new issue premiums. During the crisis we learnt a bit from the US market, which is much more focused on all-in costs.

As soon as you have issued a bond with a spread of 600bp then you probably care more about the overall costs. It has definitely changed over the last few years.

Martin, Virgin Media: There is a balancing act to be done. We like to believe that we have good relationships with our bond investors, as well as the banks. From that perspective I don’t want to see the bond move by two and a half points in either direction when it goes on the break. If there’s a modest – modest – uptick in the price of the bond, so the investor feels good about it, that presages a degree of success for next time.

We try to issue in two currencies. That allows a degree of tension between the books, which we find helpful.

Also we set up a fee schedule with the banks, so there is an incentive as well as a base component. We try to set those incentives across a range that common sense tells you actual pricing is likely to fall, and then you can calibrate that on the day when you’re actually out in the market.

Val, GDF Suez: Many companies like ourselves have a large part of our debt at fixed rates – but we manage our floating rate interest rate exposure with a hedging programme. Therefore, we do care about our new issue premiums and credit spreads, and we manage them very carefully.

Klaric, Sanofi: There is also a human element. As a CFO or treasurer, your performance is judged on your spread, not on the absolute interest rates. There is a factor of, "I’m going to fight to show my boss I am doing a good job here and get those 5bp."

EUROWEEK: Do you think American treasurers are judged differently?

Martin, Virgin Media: Harshly. It’s a very difficult life. Less glibly, it is a bit different. I come from the States, and I would say it is not as binary as whether an interest margin was ‘good’ or ‘bad’.

It is of course important to reduce net interest expense with time, but ultimately the board are most keen to see us optimise our weighted average cost of capital, not simply our weighted average cost of debt.

Bringing down the latter is certainly desirable, but at day’s end, it is the proportions of equity and debt which lead us to retire the more expensive part of our capital structure, being the equity. It’s really the WACC that they seek to optimise rather than WACD. 

Part 2: Bank and corporate funding costs – how long can it last?

EUROWEEK: Banks are funding themselves more expensively than companies over a five year term. Obviously, banks can also fund more cheaply at shorter terms. But how sustainable is this tiering of credit spreads? Is it going to change back to the more traditional tiering and will that be tumultuous or a good thing?

Wohlin, Deutsche: You may have nothing that resembles ‘normality’ in the years to come. There is a mountain of debt out there, which there is no easy solution to. We will have volatility and an abnormal environment.

Could we see corporates being a port in the storm? Yes, for the foreseeable future, because the problems elsewhere are huge. One positive in such volatility is that with a low growth rate we are likely to have very low underlying rates.

Therefore the volatility will be at the lower end of the rates spectrum. Quite possibly for some time you may see corporates trading inside the sovereigns, agencies and banks.

Honestly, I have no earthly idea why the bank lending market is operating the way it is, because it doesn’t make any sense, if banks are trying to run a positive net interest margin. You can’t borrow at 200bp or 300bp and lend at 100bp for a very long time. It just doesn’t work.

Over time that will adjust itself, but it will probably take some time.

In the mean time, or as part of such repricing, we will see more issuers gravitate towards the bond market. In Germany for example, many companies defined as Mittelstand may move to the bond market over time, picking up speed as banks reprice and resize some of their lending.

Klaric, Sanofi: One of my concerns is, what are bank relationships going to become? We have about €13bn of standby facilities undrawn, but there is no way a bank can afford to keep that, the way we are paying for it.

You cannot have a substitute, if it’s undrawn. We are not going to issue debt and sleep on a pile of cash.

Which is also a problem – in fact my main problem today: what do I do with my cash and where is it safe to keep it? Apart from buying back shares or making acquisitions?

It’s not good to have banks that weak for a long period, and if it’s a problem even for large companies, then for small companies that can’t afford or will not go to the bond market, what do they do?

There is a big threat to growth, globally, if small and medium sized companies have to pay twice what they used to for credit. This is going to kill investment.

The reversal in the hierarchy is not sustainable for a long time, but is there for a few years. It will create problems in the way corporates relate to banks. Today my biggest problem is counterparty risk with banks – I have about €7bn of cash with banks.

EUROWEEK: One could almost say that companies should become banks because they’ve got more capital, better access to funding, huge amounts of cash and nothing to do with it.

Bay, BAML: Yes, this hierarchy is not sustainable long term. But the cost of funding for a bank is not only the senior spread. Banks can issue covered bonds and have deposits, so there is a big difference between banks with large deposits and those without them.

What makes the cost of funding high for a bank is also capital. The portion of senior debt issuance in the funding of a bank is very small these days.

You have two types of corporates today. There are large ones with a lot of side business for the banks, so the banks can afford to lend to them – even, in today’s extreme conditions, sometimes to lend at a loss.

And you have the other corporates, with limited side business. For them, in the loan market spreads should be more reasonable and at least reach breakeven for the banks.

Of course, if the normal hierarchy of spreads is re-established, it would be damaging if that happened by funding costs for corporates soaring. But a more normal step would be for covered bonds first to become established between sovereigns and corporates.

These relationships will change. For example, at the beginning of August, Spain was trading around 6%, while the best Spanish corporates were trading at 5.25% or 5.5%. Today, because of the ECB buying the bonds, Spain is trading in the context of 5% and the corporates have not changed.

EUROWEEK: Everyone seems to agree that banks are going to have to increase the return they get on loans and undrawn facilities. Has that process begun yet?

Unternährer, Holcim: It has begun already. The situation is definitely not sustainable. We need a healthy and stable banking system to support corporates and the overall economy.

The funding cost of banks has clearly become an argument in discussions about new loans. They want, and have to, pass on at least part of their funding cost to their clients and pressure has clearly increased.

In the first half of this year it probably helped that the banks were underlent. Competition is very tough in the banking industry and this has pushed down prices a bit.

But over the last two or three months it has certainly changed – especially, some banks from specific countries have pushed much harder than others.

Val, GDF Suez: I have the same impression, for the overall economy. Basel III and Solvency 2 are starting to have some consequences for big corporates.

Veffer, KPN: There is another side to it. There is still a disconnect between how banks look at themselves, and how risky they find themselves, and what the rest of the world thinks. If that doesn’t come together then this problem will be there for a while.

If you look at the return on equity and other goals that banks set for themselves, they imply that either banks find themselves very risky, because that’s the return you need for that kind of risk, or that the banks think they are not risky, but much better at making money than the rest of the world.

That is part of the disconnect. Banks need to be safer and have more equity and a lower RoE. Then their cost of funds will come down. That’s part of how the abnormal spread tiering will reverse.

I am sure part of it will also come from the income side of the banks as our spreads on bank lending go up, but it’s not the whole picture. Banks are unrealistic in what they think they can deliver to shareholders.

Bryson, BNPP: If you look at what the evolution is likely to be under Basel III until 2019, in the composition and amount of capital we have to hold, the ratios are drastically unfavourable for banks.

What that means is, if you take a rough number – 30%-40% return on equity today – that is going to be regulated down to roughly half that by 2019.

Basel III is a complex topic because, depending on who you talk to, you get different answers. Every time I hear somebody talking about it that knows this subject well, I always learn more and am surprised about the ins and outs.

But the effect is that banks will have to recalibrate the products they offer and how they price them, and it’s not just loans.

Carter, Commerzbank: Banks ultimately need their relationships with corporates. Often that relationship begins with lending, so it is unlikely that banks are going to say, "We’re not going to lend now," or "We’re going to charge you a lot more" because clients, especially better quality ones, will say, "I’ll find somebody else to do it." Our business model actually lends itself to continuing to lend.

I can’t remember many times when bank lending has been more expensive than the bond markets. I don’t think there are many at all. Maybe in 2008 or 2009 there might have been a huge panic when banks couldn’t lend money, and the bond market was the only route for corporates, but generally lending is always tighter than bonds.

Basel III, of course, is a huge issue, but there are so many different angles on where it’s going to go. Are you really going to do your lending today based on something you really don’t know the answer on, which will happen in two to three years’ time?

You should carry on doing what you do – then you can adjust once you actually have a clear picture of what Basel III will look like.

Palmer, HSBC: When banks look at loans, we look at the relationship as a whole. Funding margin is one aspect, cost of capital is another, and the client’s wallet is the other aspect. How much potential business is there on the table?

Banks are being encouraged to lend at the moment by politicians. But most banks would probably much rather be lending to the corporates we have around this table than many of the targets of that policy.

Debt capital markets have been incredibly active over the last couple of years, which has provided a lot of ancillary business to relationship banks and facilitated this drive tighter in loan margins.

But as those margins fall, the discussion when we consider the business case for making a loan gets tougher.

I would be surprised if there weren’t loans this year that have missed those return targets already. That, in itself, acts as a check and balance against a bank’s vigour in chasing loans down to low levels.

And the run rate on DCM is looking lower than it was over the last couple of years. Corporates have been incredibly successful at lowering leverage, getting cash on board through cost-cutting, pooling cash and other things, which make a lot of sense post-Lehman.

What could change that is probably an increase in M&A, but you can’t necessarily rely on that over a sustainable period of time. 

Part 3: Risk cuts both ways – corporates fear perils from banks

Martin, Virgin Media: No one here is suggesting that banks are in any way being duplicitous about their risk profiles, but there is concern on a couple of levels.

As Donald Rumsfeld called it, "unknown unknowns." At times we wonder if our banking partners truly know just what they’ve got on their balance sheets. For example, are the banks’ sovereign exposures as understood as they need to be?

Secondly, after 2008, we are all very concerned about the high levels of correlation – if something goes wrong, everything goes wrong. So if those sovereign exposures metastasise again, the effect will spill through the entire system.

Make no mistake, I don’t think the world has delevered much at all. What happened was some people made dodgy mortgage loans in my native land – it started there with the consumer – then it went to the banks, then it went to the sovereigns. That leverage is still there. The pig’s just moved to another part of the python.

And until it gets a little bit more digested you’re still going to have the prospect of systemic risk. It just might start in a different place next time.

Veffer, KPN: Part of it is our profession, whether we are treasurers or bankers. Originally I come from tax, where risk management means you try to avoid risk.

What I’ve learnt in treasury is that risk management means you buy another risk that happens to be exactly opposite. You put the two together and you say, "Now I don’t have any risk." Which, of course, is not true because of correlation.

One of the good things about Basel III is that it probably encourages banks to do a bit more of this risk management in terms of correlation and where can you put assets and liabilities.

However, in essence our profession is very much used to dealing with risk by finding somebody else to take it off your balance sheet. It’s so engrained in everything we do that it will take a long time before that goes out.

Basically, we don’t know what banks have on their balance sheets or how it’s hedged, and that’s scary for corporates.

If you depend on bond markets for your funding it’s very nice also to have a backstop facility in case those bond markets are not there. So you need the banks, but if your banks start to fall away...

Commercial paper is nice to have, so you don’t have to burden your banks by drawing on your facility. But all those markets will fall away at the same time.

The only thing you can do is have cash, which is a horrible asset for corporates, and put it somewhere safe, but I don’t know where that is.

Val, GDF Suez: Counterparty risk on the banks is one of the key issues for us today – the banks that hold our cash but also our liquidity providers. With undrawn commitments we pay special attention to the strength of our banks.

We want to have one of the strongest pools of banks, and we have started to diversify it to have more international and emerging exposure. At the beginning of August we signed an MoU with Industrial and Commercial Bank of China – the biggest bank in terms of market cap.

On the cash side, we have an automatic way to manage our counterparty risk. We have limited exposures by bank through the different parameters on our dashboard like CDS and market cap, and we manage our exposures on an automatic basis, overnight.

Testa, MTS: During this crisis one of our markets that has been strongest is our repo market, where market participants exchange cash against collateral. It is supported by a central counterparty, so you don’t have counterparty risk, which is crucial for term trades.

We are looking now at an agency cash management facility using triparty repo, where you have a neutral agent that makes sure your collateral basket remains at the rating level you have chosen.

This provides an additional guarantee to trade with your counterparty, whether you are a corporate, bank or investor, and lend your cash. We have received huge requests, especially from natural cash providers, who are different from the natural cash providers of 2005 or 2006.

They include corporates and hedge funds that, as Sergio said, now have to spread their counterparty risk beyond banks and should look at lending cash against secure collateral.

EUROWEEK: Some industrial companies are putting cash into the repo market?

Testa, MTS: Yes, it is a powerful product in this period of crisis, as long as you are in full control of counterparty risk.

On the other side you find not the top banks that still have relatively easy access to cash, but most of the other banks. Investors can choose whether to put cash in a slightly more risky basket, as long as you have a neutral agent to control the type of collateral you have.

Klaric, Sanofi: We have taken a different route. We started buying other corporates’ commercial paper. The problem is that we want to spread the risk, so we have to buy CP from many corporates. A new task for my team is to follow up the risk on those corporates. But there is not enough paper. You can do that for a few hundred million but if you want to enter into the billions you have a problem to find the issuers.

Veffer, KPN: In which maturity?

Klaric, Sanofi: It is always less than three months because we want our cash to remain cash and cash equivalents.

Testa, MTS: A repo could be an alternative in this case?

Klaric, Sanofi: It could be.

Val, GDF Suez: We already have, a few times, invested in corporate CP, but the repo market that you mention, we are just transferring the risk to depository risks. It could be a feasible solution but there’s still risk there.

EUROWEEK: Can I just come back to the point about how you manage your exposure to your banking group? Over the last two months, for example, the credit spreads of European banks have been incredibly volatile. Have you been moving cash around in response?

It’s particularly interesting because in Basel III deposits are treated as stable funding. If companies are moving them very quickly in response to market changes, perhaps they aren’t so stable.

Unternährer, Holcim: Our approach is very similar to GDF Suez’s. Before the crisis we had a purely rating-based model and we changed to a purely CDS-based model during the crisis because the ratings didn’t react fast enough.

We had to change the model several times because CDS went out of the range we were allowed to invest in. We also move around cash overnight if the CDS of a bank increases above a certain level.

But this does become a relationship issue. It goes with the general trust deficit in the banking market. If we move our cash from one bank to another that is clearly a relationship issue and the relationship managers call us up immediately.

Basel III has impacted there and it has become even more important for banks to have a stable deposit base.

Klaric, Sanofi: We always monitor counterparty risk, but we certainly stepped up our analysis a few years ago.

Like GDF Suez we have a basket of indicators that we follow. We do move our cash overnight, sometimes in a very extreme manner.

During the crisis in 2008 we reduced to zero a number of banks without any warning. We exited those banks, though we are working with them again now.

We also limit not only the bank, but the countries. For example, in the past two months I have been moving money out of Europe, which meant opening new lines and ways to monitor money in other markets.

As far as liquidity providers are concerned, of course we cannot react that quickly but we monitor the strength of the banks. Next time we renew our facilities there are a few banks that I am not going to invite any more. My analysis is that they might not be there in five years, at least not in the shape they are.

This is fundamental because this defines the core banks of the group. All side business is linked to the banks that are in these facilities.

So a very strong element of our relationship with the banks is the perceived risk we have on them.

Veffer, KPN: We are largely similar. One thing to add is that we look at banks’ CDS essentially on a daily basis, and we also have limits, but they are very difficult because they move around. So we also look relatively. I am interested in whether things go up or down, more than where they absolutely are – or whether one bank is moving up more than its peer group.

It’s unlikely all the banks will default at the same time, but it’s definitely possible that one will, so it’s that one outlier that you want to follow.

The other thing is that, as I say to my team, "Banks default over the weekend, never during the week." So every Thursday morning we sit down and look at all the banks and decide whether to take our money away or not before the weekend.

Martin, Virgin Media: The point about relative movement is very important. At the height of the post-Lehman crisis, we had a rule that if a bank’s one year CDS goes over 200bp my chaps come and see me straightaway. We may not do anything about it but I want to know.

But what do you do when everybody is over 200bp, and by a lot more than that? Then you have to consider relative measures.

What we try and do if we have concerns about a bank is to make a lot of payment runs out of that bank in the near term, so that the cash is drained naturally, as opposed to saying "Come to Papa," just because I’m getting nervous. It provides a better story when you talk to your relationship banks.

The third thing I would add to what is otherwise a standard and good set of approaches by my colleagues, is never underestimate your hedge counterparty exposure as well.

We’ve got a call strike, which we put in place in July 2010. That is one massive derivative and it is a multiyear exposure – it’s coterminous with our convertible bond’s conversion date.

So those exposures can be quite material and can be vastly longer in tenor than one’s cash exposures.

Veffer, KPN: At KPN, we need euros. We may look at diversifying, by maybe going to the Swiss market, sterling or the US, which is all fine from a funding point of view, but I need to swap that exposure back to euros.

If you take 10 or 15 year money out of those markets, or 20 to 30 years in sterling, you need to find counterparties that you trust to swap that exposure back to euros. From a risk point of view, it is not easy to find counterparties you feel comfortable with on those long terms.

Val, GDF Suez: We have taken quite a straight approach on that. We have extensive derivative exposures, including through our substantial commodity business. Since Lehman Brothers collapsed, we have put in credit support annexes so that most of them are fully collateralised. So our residual risk is substantially lower than before.

What is also key is that the level at which those CSAs gets triggered is very low. We change cash on a weekly basis.

Bryson, BNPP: I’m glad nobody mentioned that you were trying to eliminate risk. You can indeed only manage it.

Rick, you raised a point earlier, which is, in my mind, one of the core issues – correlation. The reality is, if you have a triparty repo, or a low threshold for collateralisation through the CSA, it is good to have collateral, but if everybody sells even high value collateral at the same time, the value of that collateral is going to drop faster than you can sell it.

At least you’ve got collateral and it is the right thing to do, but there is this correlation issue, which we’re all faced with. Statistically, things are not as inversely correlated as we thought they were. They are actually pro-cyclical or run in the same direction.

EUROWEEK: Are the bankers here surprised, or even shocked, to hear how sharply the companies watch your risk?

Bay, BAML: No, this is a two way relationship between banks and corporates. CSAs, for example, are also good for banks – they protect both sides. I would agree with a collateral risk but CSAs are usually really protective, in most cases it’s pure cash.

It is perfectly fair that corporates should monitor risk on the banks because the 2008 crisis put much more discipline into risk management as a whole. It also helps them realise the challenges banks face from time to time.

When they see a bank’s CDS widening by 50bp in a day because there is a simple rumour in the marketplace, they also understand that it is a two way operation. So I’m not shocked by that.

The risk is to the liquidity of some weaker banks, because the worst things usually happen at the same time. If there are some concerns at one bank on one day, then most corporates will be looking at their deposits and will probably carry out similar actions, so there is a correlation.

To nuance that, what we have seen recently is very interesting. Corporates, and markets in general, are reacting less strongly and immediately. The crisis taught us a lot of lessons. We are in a headline risk situation every day. Corporates take time to look at the risk of a specific bank and do not react immediately on a single element.

So ultimately, it is safe and reasonable for banks and corporates to monitor their respective risk. We do it, they do it and it creates a much more open dialogue between banks and corporates.

Palmer, HSBC: The last few years have been a very useful stress test for corporates and banks as to how sustainable financing models are, particularly commercial paper, which was under particular stress post-Lehman.

It is absolutely natural that both sides learn the lessons from that experience, in terms of managing counterparty risk with banks. It is a very rational approach to that stress test, which many corporates passed with flying colours and their bank counterparties didn’t.

EUROWEEK: Isn’t it rather more worrying than that? Banks should be a rock of stability in the economy. If they are going to lose deposits based on the CDS spread, which after all is a flimsy thing just traded by a few investment banks, it doesn’t make them more stable.

Carter, Commerzbank: I am nervous about the use of CDS because of how suddenly a bank’s CDS can shoot through any parameters that have been set by a treasurer, and it has to be re-evaluated on a regular basis.

For me, the secondary corporate bond prices of institutions – although there are liquidity issues – are perhaps more relevant. At the moment the CDS is a proxy for trading a market, it’s not the real price at which a bond changes hands. 

Part 4: Secondary liquidity – goal or mirage?

EUROWEEK: Investors complain that liquidity for corporate bonds at the moment is worse than ever, and a lot of them blame the banks for not wanting to trade. The banks say that is nonsense and that the investors are not willing to bid for anything. Fabrizio, you are working on a corporate bond platform to address this issue. The sceptics say it’s not going to make much difference because ultimately liquidity comes from the market participants and whatever framework you have it in, whether it’s electronic or voice, there’s basically a shortage of liquidity.

Testa, MTS: When we launched the electronic market for euro zone government bonds, we had issuers with huge outstandings like France, Germany and Italy, and smaller ones that would do frequent, syndicated issues with small outstandings.

They had very poor liquidity and a mainly non-existent secondary market. There was no good price discovery and no transparency.

Our interest now in the credit space is to get ready for what should be a change of attitude of issuers and investors when trading bonds in the secondary market.

You need to create benchmark corporate bonds with decent outstandings. You need to have a yield curve with various points – at least at two or three, five and 10 years – to be able to trade these bonds properly in the secondary market.

There are top tier corporates who already have this type of strategy. Some 10 year corporate benchmarks are as liquid as the sovereigns or supras. There needs to be an extra effort to provide banks and investors with proper, liquid instruments to trade.

EUROWEEK: Isn’t liquidity always going to be a secondary consideration for corporate issuers? I thought you would say the institutional structure of trading was the key.

Testa, MTS: The sovereign secondary market is still very much a pure interdealer, quote-driven one. In credit, the new framework will be an all-to-all, order-driven market where investors and banks, either directly or as prime brokers, will be able to route investor prices into the system.

In credit, there is nothing like primary dealers, where governments say "I will give you my business on the primary market, if you support my liquidity in the secondary market." For corporates it is not there or has gone away.

Even in the crisis, sovereigns have managed to maintain these relationships. They have moved from monitoring fixed parameters of spread and size to a more relative value, but the relationships are still there and they still heavily promote pre- and post-trade transparency, especially pre-trade. This attracts investors and gives space to tap existing issues.

I understand that companies cannot go out with a €5bn new bond in one go. But, as the smaller euro zone SSA issuers have done for several years, they may start a new line with €2bn or €3bn and then grow it by tapping directly in the secondary market.

Issuers can access our market through a special section, which makes every day a window of opportunity. If they can see there is interest, they can sell bonds. Or they can use switch option facilities to get a longer maturity or pay less for it.

EUROWEEK: Do issuers care about the secondary market performance of your debt and potential opportunities for more tapping and buybacks?

Klaric, Sanofi: We look at secondary prices for several reasons. It is one of the best indicators of the real price for new issues, beyond CDS. We have been opportunistic sometimes, doing small taps when it is favourable, but it is not a major focus. It is another element of measurement.

Unternährer, Holcim: For us it is a clear focus, and there are different elements to it. One is finding the right pricing for new transactions.

But also we, like most companies in Europe, have changed our financing models away from bank financing to more capital market financing. This has its positive sides, but with that comes inflexibility.

If you have cash, you cannot pay back credit lines any more and you need to find a way to reduce your cash. One way is to buy back bonds through the market or a tender, so liquidity is definitely important.

But trying to build liquidity goes, to a certain extent, against the strategy to be active in many markets. If you are active in several capital markets, it’s difficult to build up a yield curve in one.

In most markets, except Swiss francs, we just have one or two bonds outstanding, and then you definitely do not have the liquidity you would need for liability management transactions.

Testa, MTS: I meant, at least in euros and dollars, to look at building a proper yield curve.

Bay, BAML: That is nice, but by nature the corporate market is fragmented, so it is difficult to have true liquidity. Usually, also, corporates want to avoid any peak in their redemptions, so they don’t want transactions that are too big.

There are a lot of efforts being made, but in essence this market is an institutional, over the counter market.

Carter, Commerzbank: You have to remember that portfolio managers express their liquidity and duration through sovereign bond markets. The corporate market is not the forum to trade in and out. You are taking long term credit risk on companies you have researched and truly value.

The liquidity in August probably was worse than other months, but August and December liquidity were never good.

Look at the US, where a lot of the issues are just $250m. What is the liquidity of those any day, let alone in August? We’ve had a lot of issues this year that are sub-€500m and they’re not particularly liquid either.

Investors want this huge access to liquidity, but there are other ways they can express their requirements for it than through the corporate market.

Finally, in 2008 and 2009 there was a huge outbreak of agency brokers who became the crossers of bonds, because all the banks were terrified and didn’t do any trading.

That game is over. All the secondary trading is back with the banks and the agency brokers are reducing in numbers. That tells me we haven’t got the same secondary liquidity issues that we had in 2008 and 2009, and actually we are not that badly off.

  • 15 Sep 2011

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 96,638.56 376 8.27%
2 Citi 92,984.41 337 7.96%
3 Bank of America Merrill Lynch 77,638.40 289 6.65%
4 Barclays 76,858.25 273 6.58%
5 HSBC 63,992.87 304 5.48%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Bank of America Merrill Lynch 7,875.16 13 10.85%
2 Deutsche Bank 4,933.13 11 6.79%
3 Commerzbank Group 4,230.90 17 5.83%
4 BNP Paribas 4,102.69 19 5.65%
5 Citi 3,183.28 8 4.38%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Morgan Stanley 1,912.04 11 11.53%
2 Citi 1,426.07 7 8.60%
3 JPMorgan 1,371.27 7 8.27%
4 Bank of America Merrill Lynch 1,345.53 6 8.12%
5 UBS 1,083.08 5 6.53%