The European credit market revolution

  • 14 Jun 1999
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Everyone knew that the introduction of the euro would kickstart the development of a credit market in Europe. But few could have predicted the speed at which it would take off.

Corporate debt issuance has exploded, fuelled by the high level of M&A activity and buoyant investor demand for bonds with a pick-up over government debt.

Issuance of asset backed debt, capital securities, high yield debt and municipal bonds are expanding as issuers seize the opportunity to tap an expanded investor base that is eager for new products.

For investors, issuers and intermediaries, credit is increasingly the key to success in the euroland debt capital markets.

And the market's development still has a long way to go in terms of diversity and depth. Clive Horwood reports.

Pick almost any week in 1999 and evidence of the fundamental change in nature of Europe's capital markets since the introduction of the euro is crystal clear.

Take the first week of June. At first glance, it was a relatively quiet week dominated by concerns about the direction of US interest rates.

But look closer and the impact of the credit revolution in Europe is plain to see.

First, Olivetti creates the largest ever corporate bond after winning its hostile takeover battle for Telecom Italia.

Via its subsidiary Tecnost, rated BBB+, Olivetti raises an astonishing Eu9.4bn - almost DM20bn in old money.

As a result, Olivetti is able to reduce the size of its syndicated loan facility - the traditional financing arena for backing takeover bids - from an expected Eu10.6bn to just Eu6.5bn.

Second, Investcorp launches a Eu200m bond issue. That in itself may sound unremarkable but, as even lead managers Deutsche Bank and Warburg Dillon Read are happy to point out, such an issue would have been unthinkable just 12 months earlier.

Investcorp is exactly the kind of credit that fixed income investors in Europe would not have touched with a barge pole in pre-euro days.

It is a Bahrain incorporated investment/ private equity fund which buys companies which it perceives to be undervalued, turns the company's performance around and sells about 90% of the equity to high wealth individuals in the Arab gulf.

As well as its highly leveraged, high growth and high transactional income nature, Investcorp has two further areas of its business which have traditionally been seen as credit unfriendly - real estate and hedge fund management.

In 1998, Investcorp had visited the US private debt market because that was the only fixed income investor audience which was prepared to buy its debt.

But European investors' appetite for credit product tempted Investcorp's management to head for the euro capital markets.

Its route was a classic example of the time and effort that all three sides of the market - issuers, investors and intermediaries -have to make to achieve the successful deals that will enhance the development of credit product.

Investcorp embarked on a series of one-on-one meetings with a number of Europe's leading blue-chip investors. The lead managers backed up the effort with the type of in-depth credit research which every major house now publishes for important transactions. Investors took the time to learn about the credits. The price of the bonds was decided after a lengthy bookbuilding process. And the bonds were all sold.

Third, the increased importance of credit in the international capital markets was recognised by new BIS draft proposals for capital adequacy requirements.

These firmly put the emphasis in risk weightings on credit quality rather than the 11 year old system where asset class - whether an issuer was a sovereign, a financial institution or a corporate - determined the level of capital that had to be set aside.

Under the proposals, triple-A and double-A rated corporates would have a 20% risk weighting rather than their current 100% weighting.

The fact that Europe's capital markets have undergone a credit revolution rather than an evolution was just as starkly demonstrated two weeks earlier.

First, German media and telecoms group Mannesmann raised Eu3bn of 10 year money, in part to finance its takeover of Omnitel and Infostrade (a corollary from Olivetti's bid for Telecom Italia) - a fact that had placed Mannesmann's A1/A+ ratings on review with negative implications.

It created the largest ever fixed rate corporate bond in the international capital markets. It also demonstrated a marked shift in the company's attitude to fundraising.

As Ulrich Kürster, Mannesmann's finance director, said at the time: "For us, the creation of the euro market, together with our new credit ratings, made the transaction possible. To launch a Eu3bn issue we needed the wider European market - we could not just rely on Germany."

More importantly, Mannesmann had eschewed the traditionally cosy world of the German bank market to raise its money.

"Had we needed to raise this volume funds last year, we would probably have arranged a bank loan," said Kürster. "But whether we could have raised around DM6bn in Germany is not clear."

Incredibly, Mannesmann's new record was trumped barely 24 hours later when Repsol, Spain's national oil and gas group, launched a Eu3.25bn floating rate note.

Repsol's deal was launched at an initial Eu1.5bn, quickly doubled and then increased again by Eu250m to reach its final total. Although as an 18 month bond the deal attracted a different investor audience to Mannesmann, it was a further clear sign that Europe's leading corporates were jumping on the disintermediation bandwagon and opting for the capital rather than the bank markets.

But the new European capital markets are not just about corporate bonds. The mantra "everything is credit in euroland" is perhaps over-used, but it is accurate all the same.

With the exception of the European government benchmark issuers - France and Germany - every issuer in the euro debt capital markets now has to compete on price and liquidity terms with its peers, and not only those in their own asset class.

Diversification is the key word that investors use in conjunction with credit. They want bonds across a range of sectors: from smaller EU sovereigns offering a spread to France and Germany, to sub-sovereign issuers such as the supranationals and agencies, to high grade corporates, capital securities, asset backed bonds, all the way to high yield and emerging market debt.

It marks a sea change in investor attitudes which had been widely predicted but had, in most cases, been severely underestimated.

Old style European portfolio management has been all but eradicated. Convergence and currency plays are a thing of the past. A narrow view of bond issues on offer - which previously rarely looked beyond the boundaries of a fund manager's domestic market - has been expanded to take in a far broader horizon.

This has created a strong challenge for those borrowers which have traditionally made up the vast majority of the Eurobond markets - sovereigns, supranationals and financial issuers.

In the case of EU sovereign issuers other than France and Germany - and Italy, the size of whose government bond market affords it a competitive advantage in liquidity if not in credit terms - the euro has brought about a dramatic change in the way they market their debt.

Many EU sovereigns were over-reliant on domestic institutions as holders of their debt before the introduction of the euro.

Once the hold of their domestic currency - in which they were lenders of last resort - had been removed, these issuers were faced with a similar change to European fund managers.

They had to diversify the holders of their debt, and market their securities on a much more broadly pan-European basis.

Therefore, sovereign issuers such as Austria, Belgium, Finland and Portugal have chosen to have new lines of euro debt underwritten by a syndicate of banks, allowing these banks' salesforces to market the debt to investors who may not have been tempted to bid for bonds issued through the traditional auction process.

Supranationals and agencies have been confronted by an equally challenging environment. These issuers realise that in euroland they are competing with a much broader range of issuers.

The largest ones, such as KfW and the European Investment Bank, have decided to go head-to-head with the smaller EU sovereigns and market their products as quasi- government debt.

In the case of the EIB and KfW, they have sufficiently large annual borrowing programmes - about Eu30bn per year - to set up government-style issuance programmes which include regularity of issuance, market-making agreements and sufficient size to guarantee at least a degree of liquidity.

Despite their impeccable credit quality, the jury is still out as to whether investors will consider their bonds as a commoditised product in the same way as international investors now recognise bullet notes in the dollar market from US agencies Fannie Mae and Freddie Mac.

An agency market is unlikely to develop in euroland in the same way as it has on the other side of the Atlantic. European agencies are not a simple homogeneous group. They have different guarantees from sovereigns, and the underlying credit of the guarantor differs from country to country.

But the prize for becoming part of the agency group, if and when it forms, could be considerable. Membership would clearly distinguish those issuers from the highest grade financial and corporate sectors, and pricing benefits should follow.

Financial issuers have traditionally been able to command attractive pricing in the Euromarkets, and have dominated issuance volumes.

In the outstanding Emu-12 Eurobond market, according to figures from Capital Data Bondware, they account for 55% of total volumes.

This dominance is fast eroding. Whereas in 1998, banks and financial institutions raised the equivalent of $139bn, more than four times as much as corporate issuers, in the first five months of the euro market financial issuance (at Eu37.5bn) barely surpassed that from corporate borrowers (Eu35.8bn).

Many investors are full to overflowing with bank paper from the days when it was the only real credit product available in the former eurozone currencies.

They are loath to take on any more financial debt unless it is properly priced - a trait that has commonly been sorely lacking among many bank issuers - and would, in any case, much prefer the diversification of the corporate market.

The introduction of the euro gave Germany's Pfandbriefe issuers a boost which years of promoting their product on an international basis could not match. In euroland, German Pfandbriefe make up the single largest non-government sector.

As in the plain vanilla markets, the more frequent issuers have sought to gain a competitive advantage by maximising the liquidity of their securities. Traditional Eurobond practices such as bookbuilding and re-offer pricing are beginning to seep through.

But German issuers may soon find they will not have the Pfandbrief product all to themselves in the expanded euro capital markets.

Already, Argentaria has launched the first Spanish-style Pfandbrief issue - cedulas hipotecarias - and it may not be long before banks in countries such as Denmark, France and Sweden join the international ranks.

One area of financial issuance expected to grow as a result of the euro is capital securities. Many banks are aggressively building up their capabilities in this area, in the hope that investors will be attracted by the extra yield that going deeper into subordination commands.

The asset backed market is another sector where a virtuous circle of supply and demand could lead to an issuance boom.

Many banks in euroland have suddenly grasped the concepts of shareholder value and return on equity, and are trying to free up the overloaded balance sheets which have kept returns subdued. Securitisation is a clear option.

At the same time, European investors have been looking at the asset backed markets for several years - at first as US issuers exported their product from the US domestic to the international markets, and increasingly as European-originated assets are brought to the market.

Many are now comfortable with analysing the risk/return and trading possibilities of asset backed debt - in particular its characteristics of strong credit quality and relatively high yields.

This happy confluence of supply and demand factors has led to a boom in asset backed issuance that is likely to grow as the pool of funds in Europe becomes increasingly institutionalised.

Deals such as those for Core Funding - through which Deutsche Bank has already repackaged several billion euros worth of corporate loans - show how securitisation can meet the needs of both issuers and investors.

The high yield corporate debt market's development has been steady but far from spectacular. The deal flow has been a drip effect compared to the constant flow of high grade corporate debt.

And while investors bemoan the dominance of issuers from the telecoms industry, bankers are comforted by the resilience the high yield debt market has demonstrated since the credit correction in the autumn of 1998.

High yield spreads have returned to their pre-Russian crisis levels. The pipeline of new issues is full enough, and the number of fund managers setting up dedicated European high yield funds is great enough, to generate encouragement that the sector will continue to grow.

Are the successes of the early days of Europe's new debt capital market the result of a degree of euro euphoria? Or is the market on course to become a true match for its credit intensive US rival?

There is no doubt that, in the early days of euroland, many market participants were trying to get ahead of the game.

For issuers, that meant launching benchmark issues at ever larger sizes, pricing deals to sell and leaving a good taste in investors' mouths.

For investors, the change was even more acute. Many had to rationalise their holdings to the new reality of the euro capital markets. Portfolios which may in the past have been made up of 300 different bonds were scythed down to 100 or fewer.

Most importantly, fund managers wanting to make the shift into the credit markets threw themselves headlong into the plethora of new issues as they tried to build a corporate debt portfolio.

Even in the weeks of greatest corporate debt new issue volumes, supply rarely outstripped demand. This imbalance meant that credit spreads largely maintained their relatively tight levels (compared to the US market) over benchmarks.

At some point, fund managers are likely to stop simply buying primary corporate debt and look instead at relative value.

At that stage, new issues may no longer have the easy ride to market that has typically been the case in 1999. And, if credit spreads are re-evaluated, corporate issuers may be more shy in coming forward to borrow at wider levels.

When investors begin to trade inter and intra sector, will they have sufficient bonds to allow them to do so?

The early signs are encouraging. If a euro-based investor wants to trade between credits in the energy and utilities sector, for example, he has a number of issues to choose from - such as Elf Aquitaine, Burmah Castrol, Repsol and Total - all of them launched in 1999.

Another investor who was invested in the automotive sector would be happier still. He or she could pick and choose value among deals from issuers such as BMW, DaimlerChrysler, Fiat, Ford, GMAC and Renault.

And even more choice would on offer for a dedicated telecoms buyer. Almost every major European operator is represented - France Télécom, Deutsche Telekom, Alcatel, Telefónica, Portugal Telecom and KPN, to name just six.

But the competitive pressures on banks in euroland are intense. The wave of mergers and acquisitions sweeping over Europe is greatly reducing the number of players in the euro capital markets.

The trend is probably at its beginning rather than its end. At least a dozen banks are still competing for the right to be part of the US-style bulge bracket that the development of the euro credit markets is expected to engender.

That number is almost certain to fall further - and as the league tables on these pages demonstrate, there could be some high profile casualties along the way.

The desperate need to ensure a position in the upper echelons of the euroland league tables in its early days resulted in remarkably little buying of market share - the old bug-bear of the old Emu-12 markets.

The new discipline could be a direct result of the losses sustained by many firms in the credit market correction of last autumn. But this seemingly healthier market could be threatened as some firms react to the risk of slipping away from the top table with a desperate last throw of the dice.

Credit skills are the key to success in this new market, and those firms which have invested heavily in them may at last reap the benefits from their outlay. Those firms that can provide constant support in the credit market - from sales and trading to credit updates, rather than just research for new issues - are likely to prosper in the longer term. EW

Bookrunners of international euro-denominated bonds (excluding Pfandbriefe) - 1999
(June 4, 1999)

This weekLead managerAmount Eu mNo of issuesShare %
1Deutsche Bank16,131.637310.65
3ABN Amro9,632.60426.36
4Warburg Dillon Read9,495.20376.27
5Dresdner Kleinwort Benson9,471.86446.25
6Morgan Stanley Dean Witter7,338.44514.84
7Merrill Lynch7,157.78404.72
8JP Morgan6,813.37324.5
10Goldman Sachs5,377.68273.55
Source: Capital Data Bondware

Bookrunners of international Emu-12 denominated bonds (excuding Pfandbriefe) - 1998

This weekLead managerAmount Eu mNo of issuesShare %
1Deutsche Bank31,450.8214512.02
2Dresdner Kleinwort Benson21,563.20838.24
5ABN Amro14,430.98755.52
6Morgan Stanley Dean Witter11,564.34584.42
7Lehman Brothers10,930.84304.18
8Merrill Lynch10,375.98423.97
10Goldman Sachs9,722.78313.72
Source: Capital Data Bondware
Bookrunners of euro bonds for euroland issuers - 1999
(June 4, 1999)
This weekLead managerAmount Eu mNo of issuesShare %
1Deutsche Bank22,033.369611.32
2Dresdner Kleinwort Benson17,841.70749.17
4ABN Amro11,454.32655.89
5Morgan Stanley Dean Witter9,459.34434.86
7CDC Marchés7,754.06413.99
8Lehman Brothers7,235.00143.72
9Goldman Sachs6,735.83183.46
Source: Capital Data Bondware

Bookrunners of euro bonds for non-euroland issuers - 1999
(June 4, 1999)

This weekLead managerAmount Eu mNo of issuesShare %
1Deutsche Bank9,000.724613.60
3Credit Suisse First Boston5,212.86257.87
4Merrill Lynch4,453.33186.73
5JP Morgan4,140.17176.25
6Salomon Smith Barney3,833.33175.79
7Dresdner Kleinwort Benson3,721.5095.62
8Lehman Brothers3,685.00165.57
9Warburg Dillon Read3,316.67185.01
10Goldman Sachs2,986.95134.51
Source: Capital Data Bondware

  • 14 Jun 1999

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 417,761.51 1606 9.02%
2 JPMorgan 380,362.89 1737 8.21%
3 Bank of America Merrill Lynch 364,928.71 1322 7.88%
4 Goldman Sachs 269,252.76 932 5.82%
5 Barclays 267,252.43 1082 5.77%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 HSBC 45,449.36 196 6.56%
2 BNP Paribas 38,734.80 217 5.59%
3 Deutsche Bank 37,615.10 139 5.43%
4 JPMorgan 34,724.19 118 5.01%
5 Bank of America Merrill Lynch 33,835.53 112 4.88%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 22,475.46 105 8.65%
2 Morgan Stanley 19,057.00 101 7.34%
3 Citi 17,812.08 111 6.86%
4 UBS 17,693.89 71 6.81%
5 Goldman Sachs 17,333.10 99 6.67%