Nineteen ninety eight has seen the MTN market jump from the Asian frying pan into the fire of emerging markets' chaos. Yet, volumes are up on previous years and confidence is high for 1999. Expectations of a credit-driven market were more than met in 1998 but nobody guessed this would be affected by another crisis. However, this has not dampened the positive energy being generated by the advent of the euro and expectations are once again high for the new year. Marc Falconer, vice-president Euro-MTN trading at Salomon Smith Barney (Salomon), says: "1998 began with the market coming out of some wicked turbulence and it ended in wicked turbulence. The Euro-MTN has seen different cycles and different products, yet it has persisted. It's a vote of confidence in Euro-MTNs and quite a testament to the platform." Although the overall number of new programmes signed fell from 180 in 1997 to 137 in 1998, the volume of issuance off those facilities rose from $44.18 billion to $57.41 billion over the period. Total issuance rose from $436.67 billion to $750.99 billion. Perhaps the most significant development over the past year is the demise of the yen. In 1997, yen volumes totalled $100.64 billion and it was the second most popular currency for the year. In 1998, yen dropped to third position with a mere $67.36 billion-worth of issuance done in the currency. Matthew Carter, head of MTNs at Credit Suisse First Boston (CSFB), says: "The whole Japanese premium became a factor again. The yen/dollar basis swap gapped out from about 15bps to 35bps. That meant borrowers had to look for far more aggressive funding levels in yen to offset the dollar funding cost. So with investors looking for yield enhancement, the higher quality borrowers found it harder to get attractive funding through yen." With confidence in Japan's banking sector very low, foreign investors largely avoided the sector. Most yen issuance came from the so-called brown-eye issuers (offshore Japanese borrowers) like Marubeni and Toshiba, with the exception of some short-dated business from issuers like SEK and Bayerische Landesbank. But issuers had to post very cheap levels to get any business done and those buying were domestic Japanese investors. Christopher Cox, vice-president, fixed income primary markets at Salomon, says: "When one Japanese issuer was told that a non-Japanese investor was interested, it did whatever the investor asked, just to get it on board." The regional investor base is currently driving Japan and Cox warns that 1999 could see yen volumes fall even more. He says: "There is a danger that if regional customers' appetite diminishes, then the volume of yen will fall even more. What's needed is an extended period of stability." However, if the sector gains that stability, Japanese investors may well add to the surge in demand for euros. Kirsty Traill, executive director, head of MTNs at Sumitomo, says: "Even the Japanese investors, which are typically very conservative and ultimately prefer yen, will be asking for euros. A lot of investor education has been done and it's finally paid off. Suddenly, they're interested." Although initial trading in the euro's first week was fairly thin on the ground, the ecu/euro stormed into third position of 1998's currency league table with $53.62 billion issued off 340 issues. This is hot on the heels of yen issuance for the year which totaled $67.40 billion. At the same time, last year's predictions that sterling would be a currency to watch in 1998 proved true, especially in the fourth quarter. Issuance jumped from $3.63 billion in the first quarter to $15.83 billion in the last quarter, helped along by widening spreads after August. 1999 is also tipped to be a good year for sterling as the euro abolishes most of the FX arbitrage opportunities in Europe. Fergus Kiely, head of MTNs at HSBC, says: "Investors will not want to have all their eggs in one basket and sterling offers a good alternative to the euro." Indeed, dealers seem to agree that the three main currencies of 1999 will be the dollar, the euro and sterling. Swedish kroner and Danish kroner, the other peripheral European currencies, are also expected to see good demand as diversification and convergence plays in 1999. However, the currencies of central Europe are also tipped to be popular given the stability those countries should see as a knock-on effect of Emu. Czech koruna, Forint and zloty all hold confidence with dealers. Outside of Europe, the rand is expected to continue to provide good arbitrage opportunities. The crisis in emerging markets, not only in Russia but Latin America too, caused huge problems for banks, and investors alike but many now believe that the effects of the crisis have been contained. Falconer, at Salomon, believes currencies from emerging markets that showed promise in 1998 will still do well in 1999. He says: "Real buyers are able to distinguish between fundamentally healthy emerging market currencies like the zloty and the Czech koruna and currencies of the other extreme, such as the rouble." Without doubt, the Russian crisis overshadowed 1998. It fundamentally changed the type of business being done and investor risk/return assessments. Gavin Eddy, vice-president, global client products at Merrill Lynch, says: "It made it virtually impossible to issue in the public markets, so plain vanilla private placements took off. Investors shifted from exotic currencies and structures into plain vanilla, high grade business. This provided some really good flows in the second half of the year." Although the last quarter of 1998 saw a sharp reduction in structured notes, the year as a whole saw good demand for equity-linked notes and reverse convertible products. The simple but effective reverse convertible attracts largely retail demand and usually works very well for investors. Carter, at CSFB, says: "Earlier deals suffered on a mark to market basis when the equity markets tanked. But the sell-off drove volatility higher which led to higher coupons. There's a load of enquiry for equity-linked products generally from both retail and institutional investors. Other yields are low, so why not risk the coupon?" Credit-linked notes are also tipped to play a major role in 1999. But, because of the level of sophistication needed to understand the structure completely, and the risk it involves for an issuer's reputation, many, including Abbey National, still won't issue such notes. Over the course of 1998 attention turned to the Iberian countries of Italy, Spain and Portugal for investors willing to take on additional risk through structured products. Many dealers say that the decline in business from Japan last year was offset to a large extent by Italy. Eddy, at Merrill Lynch, says: "Italy proved to be the new Japan. Historically, it's had a high level of savings and significantly high interest rates and its investors are looking for yield enhancement through structured products. That's essentially the same scenario that exists in Japan albeit on a larger scale." The fact that Italian investors are so sophisticated and willing to take on more risk, leads many dealers to advise borrowers that all roadshows in 1999 should include Milan. The credit theme of 1998 also explains the origination trends in the MTN market in 1998 and going forward into 1999. There was a significant increase in new borrowers from Europe and second tier borrowers in general. Deborah Loades, Euro-MTN product manager at Morgan Stanley Dean Witter (MSDW), explains: "European issuers were focused on positioning their credits in the marketplace ahead of the Euro and the vehicle of choice for doing this was the Euro-MTN programme." As predicted this time last year, the number of corporate borrowers entering the market has grown and this growth is expected to continue in 1999. The reduction in FX arbitrage in the single currency market has shifted the focus to credit, as anticipated. Loades, at MSDW, agrees, saying: "But in addition, in the current low yield environment the search for yield in 1999 will further increase interest in the credit market." Other notable borrowers in 1998 have been sovereigns like Republic of Italy and the US insurance borrowers such as John Hancock, which are known as Guaranteed Investment Contracts-backed (GIC) borrowers. As they become more understood in the market, many dealers believe they will prove to be very exciting in 1999 because of their flexibility in searching for yield. The need for borrowers to meet end-of-year funding targets in the crisis meant that anomalies grew between borrowers which historically had similar funding levels. They had to pay up to get business done. Julia Ward, head of Euro-MTN and Euro-CP origination at Lehman Brothers, says: "Issuers were able to borrow discretely at unpublicised levels through the private Euro-MTN market." A huge squeeze was felt by the banking sector with massive losses causing job cuts, downsizings and strategy turn-arounds. From a borrower's perspective the knock on effect of this is very worrying. Sean Murphy, director, Citibank Credit Structures, is cautious but optimistic. He says: "It sparked concern about the banking sector's asset quality and consequently about general liquidity. This left issuers with a very challenging fourth quarter." He continues: "While the underlying concern about emerging markets and other high risk credits hasn't gone away, investors have now had time to complete their analysis of the likely impact of such exposure on individual issuers and as a result 1999 should be more stable than 1998." The lack of liquidity in the secondary market has been cited by investors as their biggest problem in 1999. Although the euro will improve this through the creation of a single European market, dealers and borrowers need to rethink their strategies in a credit market context. Eddy, at Merrill Lynch, says: "Both will need to be more innovative with existing products/processes such as remarketed reset loans, multi-dealer auctions and live postings. Some issuers may also move back towards fixed fees to promote some order in re-offer levels. Liquidity will be the key to the development of a Euro-MTN credit market." But the Russian crisis also forced investors to understand the credit market better. Kiely, at HSBC, compares European investor sophistication to a tower block. He says: "The Americans are already in the penthouse, UK investors are roughly mid-way placed and investors in Euroland are in the basement. With benign yields within Euroland, it is only a matter of time before they are forced to get on board the turbolift, understand credit outside of their domestic offerings and join the party in the penthouse." But the challenges of Emu which are now a reality, mean that competition among borrowers has increased. Many dealers have expressed the sentiment that they have had it too good for too long in terms of pricing levels and that this will not be the case in 1999. Daniel Cogoi, head of MTNs at Paribas, says: "Some borrowers will find that in order to get their funding done they will have to use their programmes more regularly and pay-up in line with market levels. There has been an obvious shift in negotiation power from issuers to investors. This is a positive development for the market - growth of the credit dimension will nicely complement the structured side of the market." Consolidation in the banking sector also means that borrowers will have to be more pro-active in 1999. Simon Hill, vice-president MTNs at CSFB, warns that issuers must use this to their advantage. He says: "There'll be more borrowers and fewer banks so they will have to cultivate their own dealer universe. There's no easy money out there, you've got to win it."
July 28, 2000
