The glass-half-empty interpretation was that one swallow could not save a very bleak summer and that the uncertain outlook for Europes economy and capital market would make the deal a one-off. The glass-half-full interpretation was that the SSE issue would foreshadow a sustained recovery in corporate issuance, with an abundance of liquidity searching for yield.
To discuss how the market is likely to develop, borrowers, investors and intermediaries gathered at the Lloyds Bank Corporate Markets Roundtable earlier this month.
Participants in the roundtable were:
Simon Allocca, managing director and head of loan markets, Lloyds Bank Corporate Markets
Simon Carter, head of treasury and capital markets, British Land
Malcolm Cooper, global tax and treasury director, National Grid
Calum Macphail, head of private placements, M&G Investments
Farouk Ramzan, managing director and head of corporate debt capital markets, Lloyds Bank Corporate Markets
Raphael Robelin, senior portfolio manager, BlueBay Asset Management
Robin Stoole, managing director and head of bond syndicate, Lloyds Bank Corporate Markets
Roger Webb, investment director, fixed income, Scottish Widows Investment Partnership
Bob Williams, head of treasury and corporate finance, Barratt Developments
Moderated by Phil Moore, contributing editor, Euroweek
EUROWEEK: Did the successful Scottish & Southern Energy bond this month establish a platform for more corporate issuance?
Robin Stoole, Lloyds Bank Corporate Markets: The deal we completed for Scottish & Southern was certainly good for the market. It was a successful transaction that reopened the corporate bond market in Europe and it was encouraging that it has performed well in secondary, but it still looks as though, for the time being, many issuers could struggle to come to the market.
Fundamentally we need to see some sort of decisive action taken on the sovereign debt crisis, but it feels as though nobody knows where this crisis is headed, other than south. And as markets deteriorate, establishing a consensus on new issue pricing is virtually impossible.
Farouk Ramzan, Lloyds Bank Corporate Markets: Markets look very bad with the crossover index pushing through previous lines of resistance. If we can get some clarity that will be very helpful in acting as a catalyst to shift the market out of its malaise. Unless a line is drawn in the sand, embodied by a clear event whether that is a default or a sustainable European bail-out package bad news will continue to filter into the market and it will continue to drop. We should be thinking about where that line will be drawn and what its effect will be, because while its easy to look at the markets and say its all doom and gloom, there will eventually be a turning point. The question is: what are the factors that will allow for the market to reach that turning point?
EUROWEEK: So, its death by a thousand cuts. What will change sentiment?
Simon Allocca, Lloyds Bank Corporate Markets: On a positive note, its worth bringing up the other side of the equation, which is bank lending. This is often regarded as the poor relation of the bond market, but it has remained remarkably robust in spite of the sovereign crisis and other market concerns.
There are a considerable number of corporate borrowers who have successfully continued to access the loan market and there are still pools of liquidity which are ready and willing to lend to the corporate sector.
Of course we all want lines to be drawn in the sand so that bond issuance can take off, so that we can have more high yield issuance, allowing the backlog of sub-investment grade and unrated issuers to come to the market and reduce their dependency on the banks. The reality is that most corporates have retained an ability to access at least one market, if not all of them.
EUROWEEK: Simon, British Land has made very good use of the loan market recently, hasnt it?
Simon Carter, British Land: Yes. British Land needs to be opportunistic and take advantage of conditions when markets are functioning well. The first markets to come back post-Lehman in the real estate space were for secured lending, driven by the Pfandbrief banks. We then saw unsecured bank lending coming back over the next 18-24 months. We went to the market in the spring for a five year £350m deal and were delighted to be oversubscribed, raising £560m of unsecured bank finance.
We set ourselves a four year financing plan that will also involve the capital markets. Part of that plan involved returning for the fourth time to the US private placement market which has been an attractive source of funding for us for many years. So what Simon says about markets being open at different times and with different appetites is very true. We shouldnt be too negative just because weve been through a short period where the public bond markets have been closed.
Clearly, markets have struggled over the summer. There have been plenty of challenges and as Robin says, nobody wants to catch a falling knife. It will only be with a period of calm that a more orderly price discovery process in the capital market can begin. When that happens we will see the stronger issuers going to the bond market which in turn will make prospective issuers and investors more comfortable about where fair pricing is. But clearly when we have one event after another it is difficult for the bond market to function effectively.
Bob Williams, Barratt: We believe that the key is to look at the whole spectrum of debt providers because you cant just rely on banks or on what youve done traditionally. You need to look at alternatives such as the Prudential/M&G fund, which has proved to be a very good source of funding for Barratt and others.
I agree that core banking relationships are absolutely key. I also agree with Simon that the private placement market has remained reasonably robust throughout this calendar year.
EUROWEEK: This is a good time to bring in Malcolm, because on the subject of exploring funding alternatives, National Grid has launched a successful retail-targeted bond.
Malcolm Cooper, National Grid: We need to raise £3bn every year, which means that the bank market isnt really an option for us. We have to maintain access to the bond market and of course retail bonds can only be part of the answer.
The initial response to our retail bond was very positive. Offering retail investors a 10 year inflation-linked bond gives them the possibility of making a real return, and with the withdrawal of the National Savings & Investment (NS&I) inflation-linked bond, there arent many products that can offer a real return.
But more broadly, we clearly need to access the bond market. Its been a while since we did anything in sterling or euros. For us, the dollar markets have been the best option for the last six to 12 months. Having done a £3bn rights issue in 2010, fortunately we havent had a huge amount of funding to do this year.
EUROWEEK: Do corporates stand out as a safe haven?
Calum Macphail, M&G: Corporates clearly had a difficult time throughout the whole Lehman crisis. But they reacted quickly, by deleveraging and strengthening their balance sheets. The result is that many corporates are now in a relatively healthy position, although there are of course macroeconomic factors that may have a negative impact.
Corporate borrowers have also completed a lot of the refinancing they need to do. So they appear to be in a much better position than many sovereigns.
Stoole, Lloyds Bank Corporate Markets: In times of financial stress, corporates generally have business models that make them better positioned to weather the storm than financials. M&A activity has been moribund and Capex is down, so corporates reliance on access to the wholesale markets is much lower than in the FIG space.
Corporate supply is down this year not entirely because of the seizure in the market. It is also due to a lot of corporates having had the luxury of being able to step back from the market when conditions are challenging. The big question this raises though is whether thats a sustainable position over a six to 12 month time horizon, and corporates shouldnt make the mistake of being complacent about access to liquidity over the longer term.
Ramzan, Lloyds Bank Corporate Markets: A revival in M&A would change that dramatically. Over the past couple of years, people have postulated how corporate balance sheets are so much healthier than in the past, and that it is therefore important for companies to hit the M&A trail to gain more market share. We havent seen this happening yet.
Every year we talk about the potential for M&A, and every year were disappointed. Weve seen deals involving SAB Miller and Fosters, and activity in the telecoms sector with FT and Vodafone. AT&T and Deutsche Telekom seem to have hit the buffers because of competition issues.
Beyond these examples, activity has been very thin on the ground. So were seeing few signs of borrowers preparing themselves to fund this M&A initially through the bank market and subsequently in the capital market. It would take a very brave corporate in these market conditions to make a big acquisition, given that the costs of funding M&A with equity are rising.
Williams, Barratt: I completely agree. It has never been more important to be nimble in the market. But its also a market in which corporates are going back to basics, which means back to sound treasury and balance sheet management.
Corporates in our sector were hit especially hard by falling house prices in 2008 but were able to move very nimbly to manage their balance sheets and run for cash rather than just adopting a wait and see attitude. We locked down stock very quickly and stopped buying land and started throwing off cash. In those times if you can manage your balance sheet efficiently your P&L might not look particularly good but youll come out intact on the other side. A lot of corporates have done that successfully in a lot of sectors not just the housebuilders.
Roger Webb, SWIP: Id echo that. Corporates have higher levels of cash on their balance sheets and are positioning themselves much more defensively with no real desire for any M&A activity. In the financial sector deleveraging probably hasnt yet taken place to the extent that is required, whereas in the corporate sector it has. So if you contrast and compare the two, the corporate sector is in a much better place for us as investors.
Cooper, National Grid: Im not sure that applies to all sectors. The one place I wouldnt want to be right now is in retail.
Webb, SWIP: I agree. We have been sent signals by the UK retail sector about whats ahead in terms of the downturn. Those signals have been very negative in the last quarter.
Raphael Robelin, BlueBay: I would emphasise that you cant completely decorrelate a corporate from its sovereign. The UK government has been the first in Europe to deal decisively with the fiscal problem in what I believe is a very positive way. This has been reflected in the performance of the Gilt market. To me, this is creating a clear advantage for UK corporates because it means that as an investor youre reasonably comfortable that the sovereign is, and will remain, solvent, and is dealing with its fiscal issues. That means you can also be comfortable looking at credit spreads against a benchmark that is genuinely risk-free.
Another competitive advantage that the UK has, of course, is its ability to print money if need be. Having the central bank fully on board is a great advantage compared to corporates in countries like Spain, Italy and even France. That makes a big difference.
But on the subject of the pessimism that we all feel, its important to take a step back. Looking at capital markets, we as investors need to recognise that when volatility is at such extreme levels and visibility is so low, be it either on the economic outlook or on the eurozone sovereign crisis, its very difficult to put a lot of risk on your portfolio. You feel that youre at risk of making ill-advised decisions and that its therefore prudent to wait for the economic outlook to become more visible and for the eurozone sovereign crisis to unfold. The danger of adding risk today is that it can make you look very stupid in a few months time. Youre more likely to get into trouble doing that than waiting, even if in hindsight that turns out to be the wrong decision.
That said, the non-financial sector is in good shape. But we may also be in a new world in which government bonds are losing their risk-free status. The result could be that the closest thing to a risk-free investment is a well-diversified portfolio of non-financial corporates. Clearly right now it doesnt feel like it. But in 12-24 months time there is a good chance this could happen.
This means that natural demand for non-financial corporate debt is likely to stay very strong. One of the risks we saw earlier this year was too much money flowing into riskier asset classes such as equities. The other was companies that were very long cash starting to releverage their balance sheets.
So whats happening right now feels horrible. But if you look at the next 12-24 months it could be good news for investment grade credit, because it could mean we see more rather than fewer flows into the asset class. It could also mean companies being much more disciplined from a financial standpoint and making sure that they stay nimble in terms of their access to the capital market.
So in 12-24 months we could be looking at a very different world where big corporates are able to raise cheaper funding from the market. Hopefully that will allow the banks to focus on higher margin business such as lending to consumers and to SMEs, which is what the economy needs.
Ramzan, Lloyds Bank Corporate Markets: Just to take issue with that, you talk about the potential demand for a well-diversified portfolio of non-financial corporate credits. Is that realistic? For some time now, the sterling market has seen an increased sectoral bias in that it is clearly dominated by the utility sector. Weve seen something like £47bn of issuance over the last five years from utilities in the sterling market. The next most prolific sector is telecoms which accounts for £16bn. Then it tails off pretty quickly.
So the diet of corporate issuance that were getting in the sterling corporate market is still very highly concentrated. The fact that the retailing sector isnt flavour of the month isnt materially relevant as far as the long-run new issue market is concerned.
Robelin, BlueBay: The question youre raising is, can the necessary diversification be achieved solely in the sterling market? Thats a very valid question. BlueBay is probably less of a sterling specialist than some of my peers around the table. But we have definitely seen plenty of business from institutions that historically invested solely in the sterling market but have reached the conclusion that theyre not getting the diversification and the liquidity they need. They are therefore looking to move to a more pan-European investment strategy in the corporate market.
I would hope that, as the disintermediation of the banking sector accelerates, which has to be one of the direct results of the turmoil were going through, banks will be unable to raise sufficient capital and will have to shrink their balance sheets. A direct implication of that has to be more issuance in the capital market, if the capital market has sufficient appetite for it.
Macphail, M&G: Historically this lack of diversification in the sterling market is exactly why we have looked at opportunities in other markets such as private placements. Obviously we can look at the corporate market on a pan-European basis as well, but sterling itself does not provide the diversification we need.
EUROWEEK: Isnt this just a temporary, macro-related theme, or is it a long-term structural weakness of the sterling market?
Macphail, M&G: For us it has been a long term theme. Private placements have been a growing part of our portfolio for the last 10 years, and this was initially driven by the fact that in the 1990s there was a very bar-bell flavour to the new issue market in the UK. There were a lot of very highly-rated and lowly-rated corporates but nothing in the middle, and a good way of accessing the middle ground was to look at private placements.
Webb, SWIP: We faced the same problem at SWIP. Historically we have been one of the sterling investors that Raphael referred to, but we have had to look elsewhere for diversification. Dollars and euros are the only way we can achieve that.
Allocca, Lloyds Bank Corporate Markets: The windows of opportunity for issuance will open and close much more quickly than in the past because of the huge stream of information coming into the market. From an issuers perspective, this means youll have to have a diversified view of the options available to you across different markets to take advantage of those different windows as they open and close. The same is true for corporate issuers, which goes back to the point we were discussing earlier about nimbleness in the new issue market. Sovereign borrowers probably dont have the same nimbleness.
Webb, SWIP: That dynamic ought to lead to corporates paying up to achieve their funding requirements, which means new issue premiums would have to be wider.
Allocca, Lloyds Bank Corporate Markets: Thats right. Also the blanket price to raise money has to be broken down and the price to raise money in a particular market must reflect the fundamentals of that market.
Stoole, Lloyds Bank Corporate Markets: I agree that achieving diversification in the sterling market has historically been challenging. But there is the potential for the sterling market to provide more attractive funding options relative to the euro market.
This is because, aside from pricing, one of issuers main concerns at the moment is execution risk. From the perspective of a syndicate desk it can be very challenging to engage in price discussions in a market so full of event risk. You never want to be in the market for more than a day, and the rules around soft-sounding are challenging. So its all about how to mitigate execution risk.
In this respect one of the factors that could ultimately benefit the sterling market relative to the euro market is a characteristic that it shares with the US, which is almost always open and where there is always a price for liquidity. The reason for this is that you can always establish a consensus among a small, relatively homogeneous group of deal-driving investors.
Similarly, in the sterling market there are six to 10 thought-leading accounts, and you know that when you get their buy-in, you have a transaction. The euro market is much less homogeneous. It is made up of asset managers and insurance companies distributed throughout a continent which is in a certain amount of disarray.
For example, the German investor base is behaving differently to the French or Spanish investor base, so establishing a consensus in the euro market is much more challenging than it is in sterling. We have seen almost no issuance in euros since July 22 and one of the reasons for that is this difficulty in establishing a Europe-wide consensus on where a new issue should price. Issuers may be obliged to price towards the higher end of what is bound to be a very wide range of price thoughts, whereas in the sterling market you can use the concentration of the investor base to your advantage.
EUROWEEK: But people used to say how much of an advantage the highly granular and fragmented European investor base was, because it created price tension. Is it still the case that, in sterling, if you can get the Prus and the Avivas and the SWIPs behind you, you know your deal will fly, and by extension, if you cant, it will be very difficult to place?
Stoole, Lloyds Bank Corporate Markets: Broadly speaking, yes. Its unsurprising that each syndicate desks list of the top five to 10 accounts that you would approach to get a transaction together is pretty much the same. Everyone knows who the thought-leading accounts are. That has been diluted in Europe as a result of the crisis. Response times in the euro market tend to be longer, and you have a broader dispersion of pricing views.
This is not to say we dont have a dispersion of views in the sterling market. On the SSE deal, for example, we had very diverse views on what the new issue premium should have been.
EUROWEEK: Does the support of key UK institutions encourage some overseas participation? Given the recent shortage of supply in euros, did you see any European support for the SSE transaction?
Stoole, Lloyds Bank Corporate Markets: Demand for SSE was overwhelmingly driven by UK accounts, as you would expect. But there were also some interesting Continental European orders. Lets not forget that while things may feel very negative at the moment we still have a huge supply-demand imbalance. Demand is there. It just doesnt know where it wants to deploy itself. Supply is scarce because execution risk is extremely high, and if corporates so wish, they can avoid coming to the market altogether. This supply-demand imbalance should ultimately have a beneficial impact on the market.
Ramzan, Lloyds Bank Corporate Markets: If you assume that the execution risk is lower in sterling than it is in euros, you would also assume that more non-UK domiciled issuers would come to the sterling market. But we have seen the exact opposite. The long term average is that about two-thirds of sterling corporate issuance used to come from non-UK domiciled borrowers. That has dramatically reversed itself recently and issuance is much more domestic. Something like 83% of all sterling corporate bonds this year have been issued by UK-domiciled borrowers.
In this volatile environment borrowers seem to be gravitating to their home market, with the French relying more on the French investor pool to support its new issuance, the Germans relying on their local investors and so on. This means we have a kind of atomisation of the bond markets, which is also causing the sterling market to remain very UK-oriented. It is this that allows sterling to benefit from an execution standpoint as regards homogeneity while Europe can be accused of going back to the future, as it were. Fundamentally, it has to be said that is a bad thing because it suggests we dont have a free flow of capital.
EUROWEEK: How much of that is a product of maturity preferences? Sterling has traditionally been attractive for its long-dated demand, whereas in these markets corporate issuers are presumably focusing more on the shorter end.
Stoole, Lloyds Bank Corporate Markets: Opportunistic issuance in sterling swapped back into other currencies doesnt dovetail particularly well with the traditional maturities on offer in the sterling market. Long-dated cross-currency swaps and their treatment under Basel III will be challenging.
But over the last three or four years the sterling markets utility with respect to the range of maturities on offer has gone up dramatically. The balance between issuance of up to 10 years and maturities of longer than 10 years is roughly equal at the moment, which used not to be the case.
Lower execution risk coupled with some very interesting movements in the currency basis may also encourage borrowers without sterling needs to go to the sterling market and swap back, particularly into euros.
Carter, British Land: Long-dated funding is attractive. But one of the problems has been that the Spens early payment penalty can be very expensive especially.
Post-Lehman, many companies with plenty of cash wanting to pay down debt made increased use of tenders. As issuers become more comfortable that there is greater acceptance among investors of tenders, it might create more motivation for them to issue longer term debt.
EUROWEEK: Going back to what Robin was saying about execution risk, how do borrowers deal with this? National Grid, for example, has a five year Capex programme of £22bn. How can you raise that sort of money without exposing yourself to heightened execution risk?
Cooper, National Grid: Most of our investor work is not deal-related. We aim to visit and update investors twice a year and ensure that were sufficiently flexible to issue whenever windows of opportunity open.
The main problem we have right now is that I dont know what sort of price we could come to the market at. If you look at the SSE deal, depending on which Gilt you use to base your calculations on, Ive seen analysis suggesting that the new issue premium was 50bp, which is huge. True, if you use the 2021 Gilt the premium was in the low 20s, but I would certainly struggle to pay a 50bp new issue premium. If that becomes the norm, Ill have to. But right now Id rather not go into the sterling market at all than pay that kind of premium.
I like to think that as a corporate we are fairly nimble. The bond I remember best was a few years ago when we managed to black out the whole of London on a Friday night. By about 7.30am the following Monday morning we took the decision to launch a sterling bond which had priced by about 11.00am that day. So you can move incredibly quickly when you want to.
Right now, I wouldnt be capable of moving that quickly because I wouldnt know what the new issue premium would be.
EUROWEEK: A deal that re-opens a market thats been shut for six weeks is clearly going to have to be priced at a new issue premium. But 50bp sounds rather high, doesnt it?
Stoole, Lloyds Bank Corporate Markets: Its a tricky discussion, because its not just a question of what the new issue premium should be. Its also a question of "premium to what?" because if you dont know where the secondary market is, the numbers look rather theoretical.
In the SSE trade, the use of the shorter Gilt as the benchmark muddied the waters further in terms of pricing.
But most people thought that for a defensive, non-cyclical, single-A credit, a new issue premium in the order of 20bp-25bp would be appropriate. For a triple-B issuer in a cyclical sector, 40bp-50bp would be right.
Unfortunately at the moment we dont have enough data points to demonstrate what the market seems to be saying, although a picture is gradually forming. Before SSE, we looked at the US market, where its reasonably clear that big blue-chips like AT&T, Schlumberger and Lockheed Martin are paying in the order of 20bp-25bp. That is probably the right level in Europe as well, but unfortunately we havent recently seen the issuance we need to test that hypothesis.
Webb, SWIP: As long as the secondary market remains broken the new issue premium will need to be higher. We cant invest our clients money at or just outside secondary market levels because well usually have to sell into the secondary market to fund the new transaction.
Stoole, Lloyds Bank Corporate Markets: The tail is wagging the dog because when a new issue is priced the secondary market moves out to meet it.
Ramzan, Lloyds Bank Corporate Markets: Unfortunately very few corporates look at their funding costs on a fixed all-in basis rather than focusing neurotically on the day-to-day credit spread.
Macphail, M&G: That is very much a UK and European phenomenon. Robin talked about the US market, and corporates in the US do tend to look much more at their all-in cost of funding, which makes them less concerned about the last basis point of spread. If its a 6% or 7% coupon and that works for them, they are happy to issue on that basis.
EUROWEEK: Simon, would you like to comment on execution risk and how you deal with it as a corporate borrower?
Carter, British Land: Were not a business that has to go into the market for funding each year. Weve always taken the view that its best to diversify your sources of funds and also the maturities of your funding. So we always try to keep our refinancing dates two to three years in front of us, which allows us to be a more opportunistic. It would be fairly exceptional for all debt markets to close for three years.
Williams, Barratt: We also aim to make certain we have a reasonable maturity spread, so were not forced to dip into highly volatile markets.
EUROWEEK: Without getting too bogged down in a macroeconomic discussion, Raphael was talking about the correlation between sovereign risk and corporate credit. Would others agree that the UKs commitment to cutting its deficit and protecting its triple-A rating provides comfort for issuers and investors?
Cooper, National Grid: As Raphael said, the beauty of the UKs position is that the government can print money, which no European government can do. To me, that gives markets a great deal of confidence that the UK wont default. It should also create confidence in the UK, which should knock on to the corporate sector.
Robelin, BlueBay: There is overwhelming evidence from the sovereign crises of Argentina, Russia and Asia that if the government is in trouble then so are corporates domiciled in the country.
So as a portfolio manager we have learned over the last few years the value of focusing far more on geographic exposure at a country level than we did in the past. This is clearly a trend that will continue. From that standpoint, just looking at sovereign CDS levels tells you that youre far better off being domiciled in the UK today than not only in the eurozone periphery but arguably even in France.
EUROWEEK: Its interesting that you mention France, which some analysts think is in danger of being downgraded. Are triple-A ratings that important? How important is the triple-A to the UK?
Robelin, BlueBay: Its not the triple-A per se thats important. What really matters is the concept of sovereign debt being risk-free. One of the very uncomfortable implications of the debt restructuring in Greece is that for the first time since the second world war were going to have a developed economy restructuring its sovereign debt. That is clearly telling the market that you cant assume sovereign debt is risk free.
That has a number of unpleasant implications. It is very positive to have risk-free sovereign debt because in an economic downturn government bonds benefit from a safe haven status. So the yields on government bonds go down, making it cheaper for the sovereign to borrow and stimulate the economy. If were in a world where when an economic downturn happens your funding costs as a sovereign rise because your fiscal position is worsening, meaning that you cant borrow more and stimulate the economy, the implications are disturbing.
EUROWEEK: But the US downgrade didnt affect the USs cost of borrowing, did it?
Robelin, BlueBay: This illustrates, as Malcolm said, that a sovereign has a huge advantage if it can still print money and therefore ensure that government bonds can be repaid. Of course investors then have to make a judgement call on inflation and other factors. But at least the risk of default is virtually nil.
EUROWEEK: So the UK is a safe haven?
Robelin, BlueBay: I would say so, yes.
Cooper, National Grid: Just picking up on what you were saying about the triple-A rating, US Treasuries tightened to an all-time low about 24 hours after they were downgraded.
Robelin, BlueBay: And look at Japan, which has also recently been downgraded. Im not convinced by the argument that it is a triple-A rating that will attract or convince investors. The important question is: is your sovereign debt risk-free or not?
Allocca, Lloyds Bank Corporate Markets: Perhaps sovereign risk is the ultimate concentration risk, whereas corporates provide the benefit of diversification. Is concentration risk important to you as investors?
Robelin, BlueBay: When you move out of any sovereign bonds considered to be risk-free, such as Gilts, Bunds or Treasuries, into corporate bonds, youre being very generously compensated for the risk of default. But you are also moving into a much less liquid asset class. It is pricing in this liquidity premium that is so difficult at the moment and that clearly justifies the break-evens being vastly in your favour. One of the big challenges for the asset management industry is that most mutual funds are offering daily liquidity on their corporate bond funds, at a time when the underlying asset class does not justify that at all. So you have to be prudent and make certain that you keep a fair amount of your portfolio in very liquid instruments just in case you see outflows.
Ramzan, Lloyds Bank Corporate Markets: I find it intriguing that decision-making on a macroeconomic basis and the impact it has on markets is becoming so much more short term-based. You could take the view that the US is approaching the bottom of the cycle, which is potentially good news, and you have all the positive stimulus from China. But is any of this having any real impact in terms of how we see sovereign risk both in the UK and Europe? No. Nobody really seems to care. And thats one of the main problems we face. Nobody seems prepared to look at things over a five or 10 year horizon because they worry that they could lose their shirt next week if they bet in the wrong direction. So decision-making today is based on things like the next step in the Greek bail-out, rather than fundamental long-term economics.
Robelin, BlueBay: Im not sure I agree. One of the core reasons why the sell-off started is that the long-term economic prospects have deteriorated markedly not only in the eurozone but also in the US. The market is reaching the conclusion that all the extraordinary measures implemented by governments and central banks have been a helpful policy response to the crisis. But they have only delayed the inevitable, and at best we are in for a very long period of extremely low growth.
Stoole, Lloyds Bank Corporate Markets: In other words, there are no more bullets.
Robelin, BlueBay: Exactly. And if theres no growth, it will be even more difficult for sovereigns to improve their fiscal positions and for banks and consumers to deleverage. So the growth outlook is at the forefront of any investment decision you make right now.
Webb, SWIP: But what would turn sentiment around most quickly would be a solution to the eurozone crisis and some confidence in the ability of European politicians to tackle the crisis decisively. Weve priced in an economic slowdown and possibly even a double-dip.
Stoole, Lloyds Bank Corporate Markets: To Raphaels point about triple-A ratings versus risk-free benchmarks, the main reason why markets are in such disarray is because people are wondering how they can price-in a worst case scenario.
Because there is seemingly no resolution to the sovereign debt crisis, people are starting to ask a question what would have been unthinkable 10 or 12 weeks ago, which is how do you price in a break-up of the euro?
So Farouk is right in the sense that over a five to 10 year horizon, now might be a very good buying opportunity. But until there is some form of resolution on the European issue, investors will remain in a challenging position.
Macphail, M&G: I would certainly agree that you have to be much more cognizant of the jurisdictions youre investing in than you needed to be a few years ago. I agree that that makes things more difficult and increases the danger of paralysis by analysis because there is so much data to sift through.
Webb, SWIP: This goes back to the point that Farouk made earlier, which is that when you see a market sell-off as ferocious as this one, we as investors would normally be averaging in. But on this occasion we know wed be cut to ribbons if we did. So were best off sitting on the sidelines.
EUROWEEK: Lets assume that Armageddon doesnt happen and try to look at some of the longer term supply-demand dynamics in the market. S&P has calculated that between now and 2015, corporates will have to refinance debt of about $8tr, of which Europe will account for half. This raises a number of questions. First, will this refinancing requirement be reduced as a result of the economic crisis? Second, if the requirement is reduced, how would you respond to the S&P warning that "we are not sure there is enough demand to meet the substantial debt refinancing needs"?
Allocca, Lloyds Bank Corporate Markets: I agree that there is a huge refinancing requirement. But as weve already discussed, many corporates are generating cash, reducing their borrowing requirements in the bond or the loan market, and holding more cash on their balance sheets.
So I would expect this total refinancing requirement to be smaller than the figure youve quoted. Most borrowers have grasped the opportunity over the last nine to 12 months to come to the market for refinancing, as some of the companies around this table have done. But there will still be a demand for issuance.
Ramzan, Lloyds Bank Corporate Markets: You also need to break down this refinancing into its component parts. Some will be done via the bond markets, be it investment grade or high yield. And some will be done in the bank market where you have both the leveraged and the non-leveraged space. So its all about bank liquidity versus fixed income investor liquidity and I dont believe the two are necessarily running in synch.
EUROWEEK: On the topic of bank liquidity, in British Lands recent five year revolver you had four new lenders coming into the facility. So not only is there plenty of capacity in the market. There also seems to be new capacity coming into it.
Carter, British Land: Thats true. In the real estate space were seeing the appearance of a two-tier financing market. British Lands focus is on prime properties, long leases and good quality tenants, and weve had a lot of demand for our financings. But if youre out there trying to finance, say, a secondary shopping centre in a poor location, it would be very difficult to do so successfully in this market.
People clearly have money they need to put to work and theyre doing this either through the bond or private placement market, or more directly. For example, were now seeing insurance companies such as Axa and Met Life coming into what would traditionally have been the banks lending space. Once they have identified the type of clients theyre prepared to lend to, they are competitive lenders.
If you have the right business model, the funding market is definitely open to you, but that is very different from saying that the public bond markets will always be accessible.
Allocca, Lloyds Bank Corporate Markets: The other variable to consider is the maturity of the debt, because, typically, the bank market wont go beyond five years. As a borrower you want to push out your maturities as far as possible and you need to access the bond market to do so. Otherwise you will create another big refinancing risk for yourself three or four years down the line.
EUROWEEK: Going back to what was said about insurers like Axa and Met Life coming into the market, is this being driven in part by Solvency II?
Carter, British Land: Yes. Most institutions are assuming that direct lending to real estate will carry a relatively low capital charge under Solvency II. But insurers are also aware that banks face challenges and they are spotting an opportunity to step into the market.
Webb, SWIP: If I was a triple-B borrower with a reasonable funding requirement and I liked where yields are at the moment, I would be shipping my funding in. This is because the baseline assumption is that for the issuance community in the UK, this sort of funding is going to become more expensive. If youre a triple-B utility, for example, with a preference for longer tenors, you should be raising this funding now, because with the long Gilt at 3.5% today, spreads really should be going wider.
I also think well see a broader ratings dispersion of spreads. Solvency II, for example, in its simplest form is based on the two inputs of maturities and ratings. So it naturally pushes funding costs out at the long end and for lower rated borrowers.
EUROWEEK: But doesnt it also encourage a more general migration from equities to bonds, albeit at the short end?
Webb, SWIP: Yes. Theres a positive dynamic there, but for lower rated corporates this only applies at the short end of the curve.
Robelin, BlueBay: With the new regulation we are trying to make the banking sector safer and were trying to make the insurance sector safer. But at the same time were telling financial institutions that they can buy as much government debt as they want and get a zero risk weighting for it. Thats crazy.
Cooper, National Grid: I question why we needed Solvency II in the first place. As far as Im aware, apart from AIG, there have been no real problems in the insurance sector. And AIG was a derivatives issue anyway, so Im not really sure what problem Solvency II was designed to solve to begin with. We now have this bizarre situation where for risk-weighted purposes Greek government debt is five times more attractive than a National Grid bond.
Stoole, Lloyds Bank Corporate Markets: Yes, but then the Greek debt is yielding 55%.
Cooper, National Grid: True, but if I was an investor I know which of those two Id prefer.
But if you look at it from the insurance companies perspective, Solvency II means theyre paying a tax on providing annuities because theyre being required to allocate more capital to annuities. Normally if youre required to allocate more capital, its usually the supply side that pays. So the cost of the annuity should go up. People are saying that the yield on bonds is going to have to go up to pay the tax. But surely annuity yields that should be going down, which will ultimately hammer peoples pensions. So Solvency II to me is a complete mystery.
EUROWEEK: Is it not just a very effective political tool for forcing investors to buy more government bonds at precisely the time when governments need more money?
Cooper, National Grid: If Solvency II was started today, that could be the argument. But the initiative started years ago well before AIG.
EUROWEEK: If there is a big refinancing requirement ahead, does it mean that corporate borrowers are going to have to look at a much broader range of funding options? If so, will US Private Placements play a prominent role? There certainly seems to be plenty of demand. Didnt British Land set out to raise $200m in the market but eventually came back with $480m, across a whole range of maturities?
Carter, British Land: Thats right. This was our fourth issue in that market, so we know the investor base very well. One of the attractions of the US private placement market is that we can borrow on exactly the same terms that we have in our bank facilities. That is good from the investors perspective but it is also very helpful from our standpoint because it makes the process so transparent.
Youre right about the flexibility the market provides in terms of maturities. You meet all the investors and if any wish to lend money with a specific maturity and that matches our needs, thats fine for both parties. In our case we set out with four different maturities out to 15 years which we ended up issuing in, but it is possible to change the maturities mid-way through the process. So its a very flexible funding tool.
Also, we priced the transaction the day after the Greek confidence vote and it would have been much more challenging to have done that in the public market. But because youve been to see the investors, and because youve created a dialogue and built up a relationship with them, there tends to be more trust on both sides. US private placement investors also take a very long term view of the market which suits companies in the real estate sector.
Williams, Barratt: Weve also been active in that market and as part of our refinancing in May we did a small reverse enquiry transaction. As Simon said, its very much a relationship-driven market, and its certainly been our experience that its probably more stable than the public market as a result. If you commit to maintaining a dialogue with your investors it is a market that works very well for both parties.
EUROWEEK: What are the drawbacks of the USPP market? Arent disclosure requirements quite onerous, and have there been covenant issues in the past?
Carter, British Land: One of the potential downsides may have occurred when one of the house builders sought to amend covenants as there was an additional investor base to negotiate with.
Williams, Barratt: You have to treat your private placement investors the same way as you treat your banks. So if you amend your bank covenants you will probably need to make the same amendments for your private placement investors.
Macphail, M&G: As a private placements investor I would say that where there have been tensions between borrowers and investors it has largely been a result of lack of effective communication between the two. Typically borrowers are used to the need to talk to their banks earlier if they run into difficulties. Problems have arisen when borrowers have chosen to talk to their banks first and have waited until later to have the same discussion with their private placement investors. Investors dont appreciate these discussions being presented to them as a fait accompli.
Its interesting that US insurance companies have invested so much in terms of assets and human resources into developing the private placement market, while it has remained such an orphan asset class among insurance companies and other investors in Europe. Clearly there are different regulations and dynamics at play, but you would have thought that the opportunities that have been presented to US insurance companies would also appeal to European insurers.
EUROWEEK: Germany has a thriving Schuldschein market. Isnt that the closest we get to the USPP model in Europe? Why is it that the foreign borrowers in that market are generally only those from German-speaking countries like Switzerland and Austria?
Cooper, National Grid: Weve tapped the Schuldschein market. We were very comfortable with the transaction and with the price we paid. Weve also done some small US private placements and for us the biggest difference between these markets and the public markets is the workload involved.
If we do a public bond, especially in the UK or Europe, we can do it off an EMTN programme, the documentation is minimal, and its no more than a few days work for one of our team members. In something like the Schuldschein market, it probably takes as much as a month and a half to get all the documentation done. As we typically need to access markets 10 or 12 times a year, it would be impractical from a workload perspective to do so on a regular basis in markets like the Schuldschein.
Ramzan, Lloyds Bank Corporate Markets: The depth of these two markets is also a factor. The average issue size in the US private placements market this year is still only $230m. On the other hand, availability is always there and this year weve seen good volumes in the market and a lot of cross-border activity. Issuance by non-US companies into that market accounts for at least two-thirds of the total, and Europe accounts for about 40%. So its a well understood, well utilised market.
The only problem is the range of credit quality. In the last two years, there has been no sub-investment grade issuance in the open US private placement market. Issuance has been restricted to NAIC [National Association of Insurance Commissioners] rated one and two, and nobody wants to take the leap into the high yield area because the public market is more than happy to cope with that risk.
On Calums point, people have talked for years and years about a similar private placement market in Europe but its never taken off.
Macphail, M&G: You drew the comparison with the Schuldschein market. But clearly German insurance companies have mark to market and other incentives to invest in that market which UK insurers dont have. So we dont have a level playing field. Whether or not Solvency II will change that, I dont know.
Cooper, National Grid: Is liquidity an issue? Raphael made the point earlier that corporate bonds are illiquid compared to governments, but presumably private placements are totally illiquid?
Macphail, M&G: Theyre not totally illiquid. Clearly if youre a European investor buying public bonds in euros and sterling they will become illiquid in comparison. But Compass, for example, has just done a $1bn private placement. I would argue that there will probably be as much liquidity in that issue as there would be in a typical corporate bond in Europe.
But the question of illiquidity is often asked and is definitely part of the investing dynamic. You accept as an investor that youre going to be there as a buy and hold investor until maturity. Sometimes a high price is paid for liquidity but in times of stress that liquidity disappears anyway, which makes you question its value in the first place.
Carter, British Land: We tend to see the buy and hold dynamic as a positive factor, because it helps us to build a relationship with the investor over an extended period of time. That can then lead to reverse enquiry, which has been a driver of our issuance on occasion in the past.
EUROWEEK: Malcolm, you spoke about your recent retail bond, which is another alternative for corporate borrowers looking to diversify their funding sources. But you also mentioned the workload involved in private placements and I guess one of the drawbacks of retail bonds is that they involve a vast amount of work?
Cooper, National Grid: We launched the first ever retail-targeted RPI-linked bond this month. Its true that it involves a lot more work than a conventional public placement. But if its successful, our intention would be to access the market again and the intensity of the workload is likely to tail-off in subsequent issues.
In terms of liquidity, it seems that if there is a shortage of liquidity this comes when investors are trying to buy rather than sell. On ORB [the London Stock Exchanges Order Book for Retail Bonds] you can sell very easily. Its when you want to buy that you may have a problem.
If this deal is a success we will consider tapping the bond in response to further demand. For us its a toe in the water and well have to see how it pans out. But its certainly less work than the Schuldschein deal.
It has opened up a new investor base for us. At the kick-off meeting in London in early September we had 73 broker-dealers. We also went to meet broker-dealers in Leeds, Manchester, Jersey, Guernsey and the Isle of Man, all sorts of places that you wouldnt normally visit on a public roadshow.
EUROWEEK: There have been initiatives in the past by borrowers like the EIB aimed at drumming up more interest in bonds among UK retail investors. Why havent UK retail investors had the same enthusiasm for bonds as their European counterparts?
Cooper, National Grid: For a very long time the EU Prospectus Directive made it totally unworkable. If you go back 15 years, UK corporates used to issue bonds in denominations of thousands which made it possible for retail investors to buy them. The EU Prospectus Directive absolutely killed that off.
That directive has now been lightened and the documentation requirements for retail issues are slightly more onerous than for a public bond, but not hugely so. Its manageable now, whereas six or seven years ago it was completely unmanageable. At one stage you had to translate the Prospectus into every language of the EU.
Stoole, Lloyds Bank Corporate Markets: I find it interesting that this retail bond movement is happening now, in a very low yield environment. To answer your question about why retail investors havent historically bought bonds, I think its a cultural phenomenon. We have a well-developed and decades-old equity culture in the UK, but bonds hadnt worked their way on to retail investors agenda until the rise of corporate bond funds that coincided with the onset of the current low interest rate environment.
Retail bonds are highly work intensive from a sponsoring banks perspective; they are not particularly large and therefore not especially remunerative, and there is lot of work involved in small ticket secondary market making. So its not an entirely simple or obvious proposition. It does provide issuers with some diversification, although not necessarily arbitrage opportunities. Hopefully this market will take off, because its another potential source of liquidity, which has to be positive.
EUROWEEK: Presumably the inflation-linked angle will appeal to retail given that they have so few alternatives for protecting themselves against inflation?
Cooper, National Grid: Yes. What we think will be appealing is that it offers a guaranteed real return. There are very few places where retail investors are given that sort of guarantee. Its a 10 year bond, so if youre approaching retirement, putting away some money into an index-linked bond where you get the principal plus inflation in 10 years time is quite an attractive proposition.
Webb, SWIP: I agree. Retail investors in the UK have bought bonds in the past, but generally only through funds. The corporate bond sector in the UK is worth £45bn, which is material. But retail investors have had very few options for buying index-linked, bar through products such as the M&G fund.
But the other challenge is to explain the meaning of real returns to the man on the street. Going back to Robins point, everybody understands equities because we have an equity culture in the UK. But there is much less understanding of how bond markets work.
EUROWEEK: But at the same time a recent piece in the FT said that retail investors seeking to trade corporate bonds through online brokers such as Barclays Stockbrokers typically have to pay phone-based commissions of about £50, compared with £12 for equities. In a £1000 trade, thats nothing to do with culture. Its a rip-off.
Are there similar deals to National Grids in the pipeline, or is a structure of this kind only suitable for very few companies?
Ramzan, Lloyds Bank Corporate Markets: Obviously the name has to be recognisable to retail investors which narrows the field. But this is why retailers are likely issuers of these bonds, even though the retailing sector is going through a very difficult period. Weve seen retailers like John Lewis, for example, offering bonds to retail investors.
EUROWEEK: What other sources of funding diversification are you looking at? National Grid has issued in the Maple market, hasnt it? But are you looking at things like Samurais, Aussie dollars, even renminbi?
Cooper, National Grid: We were actually roadshowing a Samurai deal the day Lehman collapsed. So that was unfortunate timing. But were prepared to look at all markets that are available. Ive even roadshowed a Czech koruna deal with Farouk in Prague, where we met the entire institutional investor market in one day.
Renminbi probably wouldnt work for us, because I believe you need to invest the proceeds in China. The renminbi-sterling swap is likely to be prohibitively expensive.
Ramzan, Lloyds Bank Corporate Markets: But havent we been talking about this more general move from the bank to the capital market for years? There has been some movement, but not the complete reversal of the 70/30 funding split between loans and bonds that people said they were expecting years ago. The bank market has come back very strongly recently and in some ways it has even crowded out the bond market in sterling and other currencies.
The bank market has been stop-go at times, but it does seem to be flush with liquidity. Banks have been prepared to support their corporate customers with liquidity, but the core banking group that has been stable for some time, has shifted away from the well-known stalwarts when it comes to funding loans in US dollars.
EUROWEEK: In niche currencies were talking about issuance volumes that are tiny. By contrast, capacity in the bank market is enormous, isnt it?
Allocca, Lloyds Bank Corporate Markets: The banks say they have reduced their non-performing exposures and are ready to start lending money again; theyre ready to underwrite; theyre ready to provide borrowers with whatever it takes to get them from A to B.
Weve seen the proof of that, be it in the case of SAB Miller or a borrower like BHP Billiton where banks have provided large volumes of funding. But also if you come down the spectrum and look at crossover type credits which many institutional investors have shied away from, banks are lending into that leveraged, high yield market as well.
We recently saw Fresenius reopening the high yield bond market, and hopefully that will come back. But for the time being the bank market is filling up that space.
EUROWEEK: On the subject of bank lending, is the UK Banking Commissions report on ringfencing likely to have an impact not on the BHP Billitons of this world but on mid-cap corporate borrowers?
Allocca, Lloyds Bank Corporate Markets: We still need clarification on the definitions of retail and investment banking and precisely where any ringfences will be set. But the service that banks provide to their customers on the lending side will remain pretty much unchanged.
Cooper, National Grid: Isnt it the case that the integrated banks have subsidised their retail banks with their investment banking? If you ringfence them, you do away with that subsidy, which has to push up borrowing costs.
Macphail, M&G: Historically corporates have benefited from Londons role as a financial centre and from the fact that the market has been overbanked. Corporate borrowers have been able to take advantage of that to secure better pricing than they might otherwise get.
Lending tends to be the loss-leader that is used to generate ancillary business. As a result, mid-caps especially are often surprised that they cant get the same pricing in other products as they do in the bank market.
Allocca, Lloyds Bank Corporate Markets: This mid-market pricing tension is probably more of an issue in Europe than in the UK, where the pricing and terms offered to borrowers are reasonably homogenous. But when you go into Europe, there is a very big difference between pricing for mid-market borrowers and the investment grade borrowers.
Macphail, M&G: Isnt that homogeneity exactly the point? If all these corporates are being given similar pricing and terms, some will be getting a raw deal but others will be getting an extremely good deal.
EUROWEEK: Looking at likely longer-term supply patterns, Id like to come back to the point Farouk made about M&A and about how expensive it is for companies to use equity to make acquisitions at the moment. Isnt the flipside of this that there are some very cheap buying opportunities for companies looking for inorganic growth? And if equity valuations remain depressed, wont there come a point when equity investors start demanding value creation driven by M&A share buybacks or higher dividends?
Ramzan, Lloyds Bank Corporate Markets: All the big banks are making it clear that they have liquidity and they want to finance M&A, which is of course a good thing.
In terms of value creation that is a completely separate matter. It is one of the responsibilities of companies boards to figure out appropriate strategies for delivering value.
Are the companies around this table on the march as far as M&A is concerned? Are you looking to buy market share?
Williams, Barratt: We are looking to acquire more land in prime residential areas. Were doing so off the back of the successful rights issue we did in September 2009. So its an organic growth strategy which doesnt compromise the strength of the balance sheet, as we touched on earlier. Corporates will have long memories in terms of over-gearing.
Cooper, National Grid: I wonder if investors will have equally long memories. As recently as July 2007, we had people pushing us to gear up and do a share buyback. A year later those same people were questioning our ability to fund.
My concern is that its only a matter of time before we find ourselves under renewed pressure to do share buybacks.
Robelin, BlueBay: For the time being the equity market will be happy with defensive stories that pay a high dividend yield. If you look at the leverage clock, earlier this year we were approaching the point that gets a uncomfortable for bond investors where companies are tempted to re-leverage and are under pressure from their shareholders to do so.
If anything, the events of the last three months have delayed that process. Given the extremely uncertain outlook, the risks of re-leveraging have decreased, not increased. This is a market where it shouldnt be too difficult to explain the value of a strong balance sheet to your shareholders.
Allocca, Lloyds Bank Corporate Markets: Our clients seem very comfortable with looking at class two-type acquisitions. But theyre much less comfortable with class one acquisitions and the impact these may have on their balance sheets.
Stoole, Lloyds Bank Corporate Markets: It feels to me as though were about to enter a period where the lessons learned in the aftermath of the Lehman collapse come to the fore again. If you chart borrowers funding costs over recent years, obviously in later 2008 and early 2009 spreads were greatly elevated. Those borrowers that had access to several sources of liquidity dollars, euros, sterling saw their borrowing costs fall much more quickly after that than those that didnt. So the lessons of the benefits of funding diversification have been taken on board.