Corporate liability management in a world of European quantitative easing
After a strong start to the year, liability management activity came to a halt following the ECB’s announcement of its corporate sector purchase programme, prompting questions as to how this latest stimulus package will affect the market. Despite the slowdown, however, there is reason to believe an uptick in activity is on the horizon, according to UniCredit’s Liability Management team.
Debt capital markets started on a weak footing this year, with lower global growth outlooks and slumping commodity prices resulting in increased market volatility. Primary market activity was significantly lagging behind last year’s volume, with secondary market performance subdued in the initial months of the year.
Yet following the ECB’s March announcement that it planned to increase spending and add corporate bonds to its asset purchase programme under the new Corporate Sector Purchase Programme (CSPP), overall market sentiment significantly improved — tightening spread levels and increasing cash prices. This, in turn, spurred a boost in primary market activity, with increasing investor confidence demonstrated by high levels of oversubscription and improved market depth in primary market transactions.
Interestingly, the liability management (LM) market was not affected by the adverse market conditions at the beginning of the year. On the contrary, corporates continued to redeem bonds in line with recent years’ tender volumes, with strong first-quarter activity driven by relatively low cash prices, elevated spread levels, and high cash positions on corporates’ balance sheets.
Tender volumes of IG corporates*
Since the announcement of the CSPP, however, the LM market for euro investment grade (IG) corporates has halted, raising questions as to how the ECB’s latest stimulus package will impact the LM market and what will drive the market going forward.
The issuer’s perspective: managing liabilities to capitalise on favourable market conditions
With the ECB about to kick-off corporate bond purchases at the end of Q2, corporates will take a close look at opportunities to optimise their funding structure. For example, companies with outstanding bonds maturing in two to three years would typically look to refinance this debt around six months before maturity. However, significantly improved refinancing conditions following the CSPP announcement are providing a strong incentive for firms to buy back the bonds now in order to capitalise on market demand, with new offerings expected in the upcoming months.
Solid cash positions, limited short term investment needs, and a reduced cost of carry make LM an ideal alternative, especially now, when funding conditions are highly attractive.
Over the coming months, we can expect to see corporates looking to combine a tender offer (a bid to buy back outstanding bonds from investors) with a new bond offering. Although buying back bonds via public tender offers usually requires a premium, corporates will see this as a reasonable price to pay to optimise their debt profiles. Next to the attractive spread and issue yield levels, current access to longer maturities (of around 12 years or more) will motivate issuers to tender outstanding shorter maturities and replace them with longer dated paper.
Even for corporates without any refinancing needs, deleveraging with a pure cash tender offer still represents a suitable option. Of course, with bonds currently performing well in the secondary market, cash prices have increased significantly, making a cash tender offer more expensive. This means that, from a purely economic perspective (looking at the P&L impact to maturity of the tendered bond), a buy-back at current market levels hardly offers a benefit — if any at all. Rather, it will be in terms of gross debt reduction and avoidance of investments in negative yielding assets that these tender offers will show their value.
The investors’ perspective: LM as an attractive opportunity in a bullish market environment
Based on the improved market sentiment fostered by the CSPP, tender offers are likely to be welcomed by investors. Not only will these enable them to lock in a premium return on their investment, they will also offer the chance to exit investments at an opportune moment, providing extra funds when numerous new offerings are likely to be hitting the screens.
The acceptance of any such tender offers, reflected by the final take-up rate, will depend on several criteria:
(i) Price: asset managers, who represent the majority holders of IG-rated corporate euro bonds, will demand a premium on the current trading level — typically in the region of 20bp-25bp;
(ii) Market expectation: if investors remain bullish in the upcoming months, they will likely favour longer maturities which typically provide a certain pick-up. Since most tender offers involve shorter dated bonds, investors will be keen to sell these notes and replace them with longer dated ones, especially in the primary market;
(iii) New issue activity: investors aim to keep their money working, and tend to look for direct reinvestments when a bond is tendered for cash. Positive primary market momentum will create greater options for investment — encouraging investor participation in liability management exercises (LMEs).
LM growth expected throughout Europe
Given the incentives for both issuers and investors, there is reason to believe that we will still see increased LM activity unfolding across a range of sectors, driven by regular debt capital market participants, including utility, telecommunications and industrial companies throughout Europe.
From a geographical perspective, we have observed significant differences between the volume split in the LM space and the usual primary market split, where France, Germany and the UK are dominant.
Geographical split by corporate IG tender volume (2014-2016 ytd)*
In Italy, for instance, LM activity has been on the rise for the past few years, with high success rates feeding back to create strong demand. And with ECB stimulus measures offering a valuable window for them to lock in favourable rates, we can expect Italian corporates to continue this trend with increasing activity in the upcoming months.
This momentum also holds true for other southern European countries, such as Spain and Portugal. With a total volume of over €60bn in bonds due within the next five years (iBoxx IG corporate non-financial constituents from Iberia and Italy), we expect to see a decent share of those bonds being redeemed via tender or exchange offers.
France, meanwhile, will likely continue its recent strong activity. Comprising some of the most active companies in the LM space, French corporates show a particularly strong appetite for LMEs — a predilection which will only be accentuated in the current market conditions, with further growth in corporate buy-backs the likely result.
The most significant growth potential, however, sits in Germany. In recent years, the country has seen smaller transaction volumes for LMEs than other powerhouse economies such as France. To a certain extent, this can be explained by culture. With a long history of relatively low funding spreads and access to a wide range of tenors, Germany’s growth story is slightly different from those of its peers. With many of them falling into the IG category, German issuers will not be overly worried by deteriorating refinancing conditions, and will therefore be less swayed by arguments for prefunding than firms in peripheral economies, for example.
This is reflected by the fact that German corporates have a higher ratio of new offering volumes to respective tender volumes than their counterparts in France and Italy.
Yet the future holds strong potential. With €67bn in outstanding bonds with upcoming maturities — a crucial indicator of potential new LM activity — Germany ranks second in Europe, trailing only France’s €77bn figure.
Certainly, when German corporates finally catch up with their European peers concerning their mid-to-long-term financial strategy (regarding LM with respect to P&L impact and balance sheet optimisation), we will see considerable growth in this section of the LM market.
Given the above, further growth with European corporates seems highly likely. And with US corporates playing a larger role in the euro market recently, their participation in euro LMEs may drag slightly into the future.
Seizing the opportunity
Certainly, on the back of an overall favourable market environment for LM activity in the wake of the ECB’s most recent stimulus package, now is an ideal time for companies in Germany and elsewhere to reap the benefits of LM.
Success in this respect is not guaranteed, however, and corporates will need to think carefully about how they structure and price their offers. An expert banking partner such as UniCredit can provide invaluable assistance in this task.
Indeed, UniCredit maintains strong relationships with investors — listening to their feedback on deals, and understanding what it is that makes them tick and why they accept some offers and decline others. Consequently, UniCredit can advise clients as to how they can design offers that will achieve a higher success rate by factoring in investors’ priorities and preferences — thus capitalising on the ECB’s latest stimulus package.
Authors: Hans Niethammer, Christian Schneeberger, Ulrich M. Simon and Lars Veltmann, Liability Management, UniCredit Corporate & Investment Banking
(*) Source: UniCredit LM Database