2006 was a vintage year for the global capital markets. Records were broken for the biggest deals and most issuance in different markets, and sunrise products such as high yield bonds, hybrid capital, covered bonds and structured credit expanded their scope. As Toby Fildes and Jon Hay report, many of these highs may soon be surpassed — market participants just hope none of these bull market deals end up being remembered for the wrong reasons.
The year 2000 was much in the thoughts of capital market participants in 2006. Time and again, market highs or records struck in that year were surpassed in 2006, prompting delight and a sense of triumphant conquest.
Stockmarkets bounded, issuance totals soared, spreads tightened.
The world's biggest ever IPO, the biggest loan, the biggest leveraged buy-out and the biggest securitisation were all completed in 2006 — with the Industrial and Commercial Bank of China, E.On, Hospital Corp of America and Lloyds TSB Arkle deals.
So were the biggest emerging market bond and loan (CVRD of Brazil), the biggest European high yield bond (NXP Semiconductors) and the biggest European mezzanine loan (Essent Kabelcom).
So it went on, with countless national and regional records broken and firsts established. These capital market deals were just the fruit of a year of surging change in the world economy.
Rising corporate profits finally paid off for the investment banks in a new tide of mergers and acquisitions that reached every part of the globe. The world's growth engines — Brazil, Russia, India, China and the Middle East — flexed their muscles with South-North takeovers and international flotations that would have seemed inconceivable a few years ago.
And after several remarkable years, private equity astonished even its most bullish proponents with a huge increase in deals.
Small wonder that investment bank after investment bank announced record profits in 2006.
But the year 2000 was not recalled just so market participants could boast of their achievements. The spectre of the stockmarket crash of that year haunts today's market players, precisely because 2006 was incontrovertibly a boom year.
The last boom went bust in 2000, and everyone involved in financial markets wants to know when the present cycle is going to peak. So the air was thick with warnings that the end is nigh — and with confident assertions that 'it'll be different this time'.
As stockmarkets forge into uncharted territory and defaults begin to tick up, the adrenalin is likely to run even faster in 2007. Many believe the markets may be able to ride out the year without upset, but eyes will be on the miners' canaries — US house prices, tension in the Middle East and Korean peninsula, the weakness of the dollar and any hint of trouble in China.
Sun shines on issuers
Whatever their fears, market actors were busy in 2006 making the most of the good times.
At the top of the credit tree, in the most cycle-proof markets, it was a year of plentiful demand and clement conditions for triple-A bond issuers, from national governments and supranational banks through covered bond issuers to the commercial and investment banks that produce most of the asset and mortgage backed output.
The year was marked by a dogleg in US interest rates, hinging on the Federal Reserve's decision on August 8 to hold rates for the first time for two years. Borrowers and investors negotiated the change in direction calmly and all the dollar high grade markets were imbued for most of the year with remarkable demand from accounts in the US, Europe, Asia and the Middle East.
Issuers like the European Investment Bank pushed dollar bonds for supranationals and agencies to new heights.
The picture was just as good in euros, where widening swap spreads gave top-rated issuers room to fund deeply through Libor.
In this field, the markets that really shone in 2006 were covered bonds and ABS — a fact reflected in EuroWeek's overall deal of the year, Washington Mutual's first covered bond. The accolade commemorates a historic moment — the day when covered bonds became a global product, and when the US adopted a new bond market that was made in Europe.
The year was littered with other covered bond milestones, such as inaugural deals from HSBC, BNP Paribas and the first cross-border issues from Portugal and Sweden.
Blazing the way in securitisation were Europe's banks, which plumped for asset backed funding and capital relief in 2006 with a zeal that recalled their first discovery of the product in the 1990s.
Lloyds TSB raised a staggering £7bn with its debut securitisation, parcelling UK mortgages, while HSBC, Royal Bank of Scotland, Barclays, Caja Madrid, BBVA, BSCH and Fortis Bank all stepped up their issuance.
On the commercial property side the investment banks' conduits churned out deals, Terra Firma issued a Eu5bn CMBS to finance its German rented housing portfolio and Sainsbury's used an opco/propco securitisation of its supermarkets to replace all its senior unsecured debt.
The MTN market was more subdued than some sectors, as investors were still getting over their hangovers from the collapse of the curve-steepening trade in 2005. But the banks and investors were as adventurous as ever, especially at mixing disparate risk exposures such as currencies, equities and rates in single bespoke instruments.
In the lower reaches of investment grade, the buzz was all about hybrid capital. Growth was steady in Europe, with more corporate deals that broadened the market, introduced new credits like Siemens and Porsche — two of EuroWeek's deals of the year — and moved into the sterling market, albeit thanks to a German isssuer.
In the more established financial institution sector, hybrid capital was central to acquisition financings by Swiss Re, Axa and Generali.
But in the US the hybrid market went wild — partly with anger at the National Association of Insurance Commissioners' decision to increase risk weightings in March, and partly with enthusiasm, as structures proliferated and investors showered issuers with demand, especially after the NAIC had backed down in September.
Despite the headline-hogging corporate financings all year, one market managed to grab attention without financing anything — structured credit.
A bull run in investment grade credit default swap prices in October forced the wider world to realise it had to engage with CDOs and their swelling band of spin-off products, such as constant proportion portfolio insurance (CPPI) and constant proportion debt obligations (CPDOs).
Synthetic credit is one of the favourite bugbears of anxious regulators and financial leader writers, and no wonder, since a new product is launched almost every week and even the most skilled participants struggle to keep up with innovation. Is the financial system wading deep into a mire of systemic risk or is structured credit making things safer by spreading risk?
At the moment, the best-educated minds are only guessing.
If emerging market bond specialists thought 2005 was a special year then 2006 was one of the finest on record.
Russian borrowers produced $20bn of issuance, up from $17bn in 2005. And it was not just the banks that were issuing — an encouraging range of borrowers came to market, including top companies such as Gazprom and TNK-BP in the second half.
But the Russian and CIS market had real competition from the Middle East.
Financial institutions led the way in volume, innovative structures and currencies. With rating upgrades coming thick and fast, the region's banks were keen to take advantage of interest from an expanding investor base by bringing subordinated issues and experimenting in an array of currencies.
However, some of the old weaknesses persisted, including the region's acute sensitivity to politico-economic shocks. This weakness was in stark evidence in the middle of the year when the Middle Eastern bond markets were shut down by fears of US inflation and Israel's bombing of Lebanon.
Loans at heart of M&A
The syndicated loan market, not wanting to be left out, played its part in the breaking of records in 2006. E.On, the German utility group, showed how deep the European market had become by successfully calling on its relationship banks for a Eu37.1bn loan to back its bid for Spanish power group Endesa. At that amount, it stands as the world's largest ever loan.
However, with M&A back on the menu in Europe and showing no signs of coming off, this record could easily fall in 2007.
With the dollar weak, there is a great opportunity for European companies to buy up US rivals on the cheap. Demand is abundant among banks and funds, so that competition to lend is at an all-time high, which has driven pricing down across all sectors and regions.
With M&A up, refinancings — the staple and rather bland diet of banks in the loan market for the past three years — became something of a rarity. That suggests pricing on ordinary investment grade loans may have hit bottom and tenors been stretched far enough.
In leveraged finance, as private equity firms and their lenders became bolder, everything got bigger — deal sizes, buy-out consortia, leverage multiples, subordinated debt tranches, non-bank investor commitments and secondary market liquidity.
The western European leveraged loan record — set in 2006 by the Eu11.6bn financing backing the Nordic Telephone consortium's buy-out of TDC — is likely to be eclipsed this year.
Deal sizes are sure to grow in a market that is backed to the hilt by an increasingly deep pool of bank and non-bank investors (including hedge funds) and an emboldened private equity industry which has seen many of its investments over the past five years deliver remarkable returns.
Solid assets, solid cashflows
Infrastructure finance, which began to show potential in 2005, came to the fore in 2006. The year saw groundbreaking deals such as Ferrovial's acquisition of UK airports group BAA, the recapitalisation of German motorway service station business Tank und Rast and the acquisition by the Macquarie-Eiffage consortium of Société des Autoroutes Paris-Rhin-Rhône, France's second largest toll motorway company.
With some commentators claiming that there is $25bn of equity ready to be leveraged up to 10 times and put to work in the sector over the next year, the real problem will be finding suitable assets to buy.
In the Middle East and Russia, borrowers found that in 2006 they were able to raise bigger loans and for longer terms than ever before.
Some, notably Indian-owned Mittal Steel, DP World of Dubai and Companhia Vale do Rio Doce of Brazil, found the market was even willing to provide jumbo acquisition facilities, enabling them to go on extravagant shopping trips in Western Europe and the US.
More of the same is expected in 2007, with some of Russia's biggest companies such as Gazprom, Rosneft and Severstal expected to dive into the loan market's deep pools of debt and buy up some of western Europe's most famous industrial names.