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Corporate borrowers can’t be stingy

18 Jan 2011

Corporate borrowers are the darlings of Europe’s bond markets — and could well be for some time to come. But investors will only be pushed so far. They won’t tolerate stingy new issue concessions, especially with credit markets still so volatile.

Europe’s corporate borrowers are enjoying their time in the sun. Thanks to much deleveraging and improvements in sales over the last two years, many investors see them as stronger than the FIG sector and even some European sovereigns.

Only last November, for example, Italian oil and gas group Eni printed a bond tighter than its sovereign. And Iberdrola, a telecoms group, trades inside the Kingdom of Spain in the secondary market.

This is a situation that is unlikely to change in the near future, even if Europe’s M&A market starts to pick up steam. Investors will still be attracted to corporate bonds in the primary market, given the dearth of supply from the sector in the past year and the alternative asset classes on offer.

But there is a limit to how far investors will go. For evidence, look no further than Monday and Tuesday of last week, when there was zero supply of investment grade corporate paper from European borrowers.

Sure, Europe’s overall credit markets were weak on those two days, and were yet to be buoyed by Portugal, Spain and Italy’s successful auctions. But bankers argue that corporate borrowers could still have priced deals, if only they had been willing to pay the new issue premiums demanded by the market.

Instead, most were said to be intent on issuing only if they could squeeze deals out no more than 5bp-10bp wider than their curves.

For investors, this was asking too much. They needed little reminding of Volkswagen Leasing’s Eu1.25bn deal from January 4 this year. Issued with a concession of only about 3bp to VW’s secondary curve, the deal performed well in the primary market. But it traded badly and was 10bp wider than its re-offer spread on Monday last week.

Other corporate bonds sold around that time — such as those from Banque PSA and RCI Banque — performed more strongly. Much of this was down to the fact that they offered far more generous new issue premiums of 20bp or more.

The buffer offered by those higher premiums turned out to be useful to investors when European credit markets took another turn for the worse a few days after the issues were printed.

Given the continuing nervousness over peripheral Eurozone sovereigns, this volatility is unlikely to abate soon. So corporate borrowers should take heed. They may be popular right now, but with all-in yields at record lows, investors will not buy into their deals without some protection.

18 Jan 2011