Crisis over — now the hard work begins for UK credits
UK borrowers have always been different to their European counterparts. Historically, they have been much more diversified when accessing global capital markets than their continental cousins, while also being able to rely on a core group of international — and not just UK — banks for syndicated loans. But like all borrowers, they have felt the effects of the volatility in capital and bank markets over the last few years and have been forced to adapt their financing strategies to suit. However, after five years of seemingly unrelenting market crises, the light appears to be shining at the end of the economic tunnel — recovery is finally in sight. So just how will UK borrowers approach markets in the new financing environment and have their funding strategies shifted permanently after years of turmoil? How will rising interest rates determine their choice of instruments and just how will they respond to the potential return of M&A? To find out the answers to these and other key questions, EuroWeek invited some of the country’s leading corporate borrowers and their banks to describe their recent experiences in the capital markets and predict what the future holds for them and the markets.
Participants in the roundtable were:
Gary Admans, head of funding, treasury, BP
Ben Birgbauer, treasurer, Jaguar Land Rover
Marcus Hiseman, head of European corporate debt capital markets, Morgan Stanley
Simon Kilonback, group treasurer, Transport For London
Nilay Patel, group treasurer, William Hill
Samantha Pitt, group treasurer, Network Rail
Farouk Ramzan, head of capital markets origination, Lloyds Bank
Christoph Seibel, head of corporate debt capital market Europe, RBC Capital Markets
Nina Flitman, moderator, EuroWeek
EUROWEEK: What have been the greatest changes in the market since the start of the financial crisis five years ago?
Gary Admans, BP: Increased volatility has been the main theme in all markets over the past few years. The European markets close more often than they ever did and in the US pricing is far more volatile.
Samantha Pitt, Network Rail: There have been times when even as an SSA issuer the market has been closed. A couple of years ago the markets closed and we couldn’t access financing in the same way that we had before. Also, there is increased regulation on banks and more focus on counterparty credit risk which needs to be managed. Finally, market volatility has become more of the norm and needs to be navigated.
Farouk Ramzan, Lloyds Bank: You have to have been living in a cave if you didn’t think the last five years was the greatest period of systemic change ever seen in the financial world.
EUROWEEK: How has the approach of UK borrowers to financing changed over the last five years?
Nilay Patel, William Hill: When the financial crisis hit we were a FTSE 250 corporate, financed from the syndicated bank loan market. We were one of those corporates that got a little bit caught out by the credit crunch in having all our debt financing from one market. The lesson we’ve taken on board is that it’s important to maintain a diversity of funding markets and so over the last few years we have diversified more into the corporate bond market. We’ve also reduced the absolute amount of leverage we’re comfortable with, reflecting the economic conditions and the wider investor environment.
Simon Kilonback, Transport For London: We’ve moved from borrowing almost exclusively from central governments and agencies such as the EIB to actually issuing directly into the capital markets. We have never been reliant on wholesale bank funding in the way some corporates were, so we haven’t felt that contraction in the availability of bank financing. We are aware of this contraction though, as we saw the value for money of PFI deals decrease as the financial crisis made it much harder and much more expensive to raise long term debt. Banks were far more reluctant to take that project risk. So whereas we may have financed projects or rolling stock through PFI or leasing deals in the past, that market is very different now. For us, it’s now much more efficient to finance those purchases on balance sheet, and raise the money ourselves through the capital markets.
Christoph Seibel, RBC Capital Markets: For borrowers across Europe, there was a historic over-reliance on the bank market. The onset of the financial crisis and the Lehman Brothers insolvency in particular has changed the mindset of the European treasurer of large cap corporates. Issuance activity across the capital markets has gone up. In 2008, UK investment grade issuers had about £16bn in new deals, while in 2012 it was more than double that at around £35bn. The UK issuer base was always more capital markets friendly than some of their continental European counterparts, but still their diversification into the bond markets has significantly increased.
Ben Birgbauer, Jaguar Land Rover: Our situation has been somewhat unique. The financial crisis was particularly difficult for the auto sector, while it also came before we had a chance to set up the JLR Treasury organisation after the business was acquired by Tata Motors in 2008. During that financial crisis — with the difficulties in the auto sector and with new bank relationships to be built — bank credit was very hard to come by. We wound up having to fund the business with very complicated secured debt transactions, generally for shorter terms. As our business turned around and performed strongly over the last few years, we saw an opportunity to get credit ratings and access the capital markets. Since then, we have refinanced all of that secured bank debt that we had raised with long term unsecured bonds in the high yield market. We’ve also grown our cash balances and put in place a significant undrawn long term bank credit facility for liquidity insurance.
Ramzan, Lloyds Bank: The development of the sterling high yield market in the UK is interesting. Issuance is up markedly from 2009 to 2013 — issuance year to date is about £8.7bn while last year it was £3.3bn. That’s a huge difference. There are several reasons behind this — you’ve got investors hunting for yield, a greater appetite for risk and maturity to get that yield, and also a willingness by those investors to take up the slack from the banking market as the banks experienced a reduction in the liquidity they were able to offer in the lending market. Having said that, the HY market is quite sensitive to changes in sentiment and it shuts down when the public markets catch a bit of a cold, but it’s not going to go away.
EUROWEEK: How have borrowers branched out into international markets?
Pitt, Network Rail: We’ve always gone to the international markets. Around half of our investor base is international and they’ve always been very important to us. Our core markets are sterling and dollars, roughly split 50/50 between those two currencies. Obviously we’re active in sterling, where we’re the Gilt surrogate with an explicit UK government guarantee, but we’re more focused on dollars now. Dollars is the global currency of choice for most international investors, and as a big issuer you can’t afford not to issue in US dollars. We started doing 144A issuance three years ago, so the US investor base has become more important to us.
Ramzan, Lloyds Bank: There has been a dramatic increase in the last five years of UK borrowers going to the US dollar markets. Last year, UK issuers raised about 51% of their financing in the dollar market, so there’s more dollar issuance than sterling issuance. That may be due to the basis swap, which over the last year has been particularly strong, but there has been a stronger argument for UK issuers to go to the dollar markets generally. The US market hasn’t been plagued to the same degree by the sovereign debt crisis etc, so execution risk in the US market is perceived to be lower than that in sterling or euros.
Birgbauer, Jaguar Land Rover: We have issued bonds in the US market as well as in the UK, because the size of our funding requirements means we need to issue in currencies other than just sterling. The US market is the biggest and deepest capital market in the world and so that’s a natural place to go. It also makes sense for us as we do have significant dollar revenues and so issuing debt in dollars is something of a natural hedge against our future dollar revenue.
Admans, BP: We’re an international corporate and around 70% of our bonds are denominated in US dollars, so the US is a key market for us. We treat it as our home market, which is fortunate given that it’s the biggest and deepest. However, pricing in the US has become increasingly volatile with secondary spreads moving far quicker.
The core liquidity for BP, like most international corporates, remains in US dollars and euros but given the increased price volatility we believe it makes sense to widen your pool of investors by going to other markets, as we did in 2012 when we issued in Australia and Canada.
Marcus Hiseman, Morgan Stanley: We’ve seen more Yankee issuance from UK issuers going into the US markets. The big FTSE majors have used the US market more so than they’ve ever done before and have been progressively increasing their use of that market. It’s not surprising given the depth of liquidity in the US and given the problems we’ve seen through the euro crisis. These borrowers want to depend less on raising big sums in the sterling and euro market. That said, when you look at the companies in the FTSE, many operate predominately dollar balance sheets, so effectively it makes sense for them to use the US market.
If you’re dollar functional, you want your debt in that particular currency —but the added bonus has been that the US dollar market has been deeper and more liquid than any other market. It’s also been more consistently available, it’s been cheaper than any other market and it offers the widest choice in maturity. So it’s natural that people will gravitate towards that market, and we’ve seen a greater use of the US market as a proportion of overall borrowing by a lot of the FTSE majors.
There’s actually been an awareness of late that some borrowers have probably become a bit too reliant on that market, so you’ve seen some of these issuers start to diversify. Some are looking to use the Eurodollar or sterling markets instead, while others are looking to Aussie dollar and Canadian markets to tap into new pools of liquidity. The dollar market remains the mainstay of their financing, but they add bolt-on deals in a multitude of other currencies. That’s been a major change.
Seibel, RBC: There has definitely been an increase in activity in the US dollar markets over the last few years. The UK borrower base has always been much more open to access the Yankee market than other European names, but there’s still been an increase. In fact, there’s been a general diversification into the main currencies, as well as into more local markets. For example UK corporate issuance in the Canadian market was C$119m in 2008, growing to C$400m in 2010 and C$1.3bn in 2012. There’s definitely a bit of a diversification trend. There’s a general awareness that liquidity is important, that diversified funding sources are important and that good preplanning on funding front and maintaining a good flexibility on balance sheet are good drivers of a treasury team’s decision making process.
Patel, William Hill: In 2012 we generated around 90% of our revenues in the UK. As a primarily UK business, we had generally only looked at the sterling bond market. But this year we did a significant acquisition in Australia and are looking to grow our online business internationally as well. So I can see a need for us in future looking at funding in different currencies, either directly or with swap.
EUROWEEK: How have international investors responded to UK borrowers?
Kilonback, TfL: It has been a help being a UK borrower. There have been points over the last three years when financing as a European name would have been difficult, but being a UK credit with a UK-only business insulated us a little. We have found that inward investment from non-traditional sterling investors has picked up over the last couple of years. For our most recent sterling bond deal, over 20% of the book went to Asian investors. The fact that the UK market tends to finance a bit longer is interesting to the Asian investors, especially for the life insurers and pension funds. We haven’t suffered to the degree that Europe has suffered and that makes us more attractive as well, as they feel there isn’t as much risk as with an equivalent euro transaction. For ourselves as a government-related entity, we’re at that rarefied spectrum of the credit rating that really appeals to Asian investors too.
Pitt, Network Rail: UK borrowers have benefitted from being outside the eurozone, and from investors’ flight to quality. The UK has been downgraded by two rating agencies, but we’re still pricing flat to KfW. We’re still regarded as a safe haven, even now we’re a double-A plus credit, but who knows whether that will last?
Seibel, RBC: In the last five years, the international investor base has viewed the country with varying levels of confidence. But the UK started addressing its issues early on, and that has helped it to remain a low interest rate environment. UK corporates that tend to issue in the bond markets tend to be large, multinational names, and these are the ones that are very well received by investors. As a result, UK borrowers have performed very well in the dollar market — both in Yankee format and the US PP format. They are well received companies that investors want to have in their portfolios.
Hiseman, Morgan Stanley: Canadian and the Australian investors in particular tend to have a very limited choice about who uses their local markets. The local banks are active and a limited number of local corporates choose to use those markets, so the investors crave diversification themselves. When you have a borrower with name recognition and local business presence, or a borrower who’s a global player, it makes sense for them to invest. Network Rail always benefits from going to the Canadian dollar market because of its rating, while BP leads the way with its diversification into multiple markets. Investors from outside of Europe are keen to participate in deals from these borrowers, and they like to see new credits come and raise money in the local markets. Name recognition is the most important requirement we hear time and time again from our local syndicate desks in those regions, and it really helps if they have business activity down there.
Ramzan, Lloyds Bank: US investors perceive that the legal enforcement of documentation and the UK legal structure connected to UK deals is just of a better quality. That’s why there’s always a bit of a penchant for UK names. Also, given that on a proportional basis there is still a ‘rarity’ factor to UK issuers in the dollar market the diversity play for US investors is still an attraction.
EUROWEEK: What other products have become interesting for UK borrowers?
Kilonback, TfL: We established a commercial paper facility, and we’ve used that programme alongside building out an extensive bond curve. Both of those issuance programmes will be a mainstay of our funding for the foreseeable future. At the moment we remain sterling focused but may expand in the future.
Patel, William Hill: We’ve looked at the retail bond market very seriously and have had conversations with a number of banks about that. The only reason we haven’t approached it is that our financing needs were too large. In June, we went to the bond market to refinance the bridge loan we’d taken on to fund a couple of our acquisitions. That bond transaction was big for us, and the retail market isn’t yet developed enough to support those kinds of sizes. The institutional bond market was our only option. The retail bond market might be attractive for us if it allows us to raise smaller sizes. I can use it to spread the maturity profile of my financing. That market does remain on our radar.
Ramzan, Lloyds Bank: UK borrowers’ issuance in the US private placement market has grown by a compound annual growth rate of 38% between 2009 and 2012. It went from $3.7bn to $9.8bn. The reasons for that are clear — the USPP market is much more flexible than the public bond market, you can get bespoke maturity tranching, while the unrated nature of the system works for issuers. Issuers can get pretty chunky deals done there, while issuing in dollars and swapping back into sterling gives you a pick up based on the currency basis swap over the last couple of years, a lot of UK issuers like the sound of that. You’re likely to see a continuation of UK borrowers going to the USPP market.
Hiseman, Morgan Stanley: Another trend we’ve seen is the use of hybrid capital. BG Group was transformational as the first UK client to do a significant hybrid deal across multiple markets, and that’s led the way for a lot of other corporates to follow on.
EUROWEEK: Is volatility the new stability?
Admans, BP: Yes it seems that way though you always assume the volatility will end, but it’s been crisis after crisis. The turbulence in the bond markets has also been heightened by the reduced secondary liquidity provided by the banks. As yet there seems to be no ready replacement for the lost liquidity, so you would expect credit spreads to move around faster. If an investor decides to sell a significant position and no bank is are prepared to hold the paper, then the bond’s yield can move out pretty rapidly.
Birgbauer, Jaguar Land Rover: Over the last few years there has been a lot of volatility — whether that’s from the euro crisis or, more recently, from the markets responding to input from the Fed on tapering or other events. Markets perhaps do seem more sensitive than in the past. So in that environment, you need to maintain flexibility in funding and not to put yourself in a position where you have to fund when you don’t want to fund. You want to be in a position where you can fund opportunistically and be ahead of the curve.
Hiseman, Morgan Stanley: Corporates recognise that ultimately there are so many events out there and they do their best to navigate the markets. Many of the frequent borrowers are extremely nimble in their approach to the capital markets.
Patel, William Hill: Certainly it’s an advantage to be able to be flexible. Our problem is that while we’re in the FTSE 100 we’re not an overly sophisticated or large treasury operation so it’s difficult for us to be as speedy as some of the bigger players and the regular issuers. We issued a bond at the beginning of June, but only days later government bond yields started creeping up. Had we done our deal a week later we would have paid a higher coupon. It had taken us three months to get that bond out the door from start to finish — we don’t have an EMTN programme as we’re such an infrequent issuer. So if you can be speedy it is an advantage in these markets.
Pitt, Network Rail: As noted above, I think volatility is now part of the norm. You have to be able to manage it.
Ramzan, Lloyds Bank: I’m not a Trotskyite, but I think constant revolution is where we’re at as regards the financial markets. UK treasurers are well aware of the need to have quick decision-making and have lots of optionality available, because it’s not like there’s a risk on-risk off attitude these days. People are very used to having days when a deal will work and then within the same week, it’s not possible. You do see reasonable fluctuations in sentiment that can have substantial impact on execution risk of a new deal in the market. So it’s much harder for banks to forensically gauge the levels of interest from investors ahead of execution, but I think issuers have an understanding of this when they listen to the execution advice from their bookrunners.
EUROWEEK: In such a volatile environment, how important is the role of investor relations?
Hiseman, Morgan Stanley: Borrowers are extremely forthright in their investor communication and they’re disciplined about that process. I think they’ve upped their game in regards to their professionalism in managing their investor base. That investor base has changed over the last five years. Central banks are now investing in corporate credit while a few years ago they were purely focused on government bonds, and corporates are investing in corporate credit. We’ve seen a great deal of diversification on the investor side, so borrowers know they need to do a lot of investor work to keep up. They have to be disciplined in their approach to the buyer base, and that helps with accessing the market. UK borrowers have been setting the gold standard in their investor communication work.
Birgbauer, Jaguar Land Rover: Businesses always have creditors — whether they’re bond investors or banks or otherwise — and there’s always a need to maintain relationships with those creditors. The nature of the relationship with bond investors is different to bank relationships, but there’s a need to communicate to investors whoever they are to help them understand the business. You need to let them know what’s going on with the business. Any investor providing credit to a business wants to be comfortable they understand it. It probably shouldn’t be surprising in the environment we’ve been in that the level of detail investors want to understand about a business has increased which has only increased the importance of investor relations.
Pitt, Network Rail: You can’t expect investors to come to you — you have to sell your product and differentiate yourself. While there are a lot of German government backed issuers, we are the only UK government backed borrower and the only one that issues in currencies other than sterling. So we have a unique selling point — we can say to international investors that if they want exposure to the UK sovereign outside of sterling, we’re your only opportunity. That’s especially true in the dollar market. The Bank of England issues one US dollar bond a year but we issue far more. That gives us a USP that makes us attractive to investors. As long as they’re interested in the UK credit, they know that to get UK sovereign exposure, it’s us or Gilts.
Kilonback, TfL: Over the last 18 months in particular we’ve done a lot of work with investors to get them to understand that we are a government-related issuer and that we are more an SSA than a corporate. It’s been an intense education process, but we’ve seen our spreads pretty much halve over that 18 month period. Now that we’ve established a maturity curve and have pricing points of reference from five years up to 35 years, it’s far easier to have discussions about fair value and relative value compared to other agency or quasi-government borrowers. We see our trajectory continuing to move closer to those than where we started a couple of years ago.
Ramzan, Lloyds Bank: There’s been a marked increase in the number of roadshows going out — whether they’re deal-related or not. Credit updates are on the rise, and UK investors say that they’re short of credit analysts — there are so many potential issuers in the market investors don’t have enough analysts to go to all these meetings. It’s not just about frequency, but also about the type of product in the market. We’ve seen a rise in hybrids in the UK market in the last 18 months — hybrid deals now account for 12% of UK corporate issuance year to date. So you need to introduce and update investors not only to the credits but also to the structures on offer.
EUROWEEK: What has been the focus of borrowers’ financing strategy? Is diversification still key?
Pitt, Network Rail: For us, it’s all about diversification. When you’re issuing £5bn to £6bn a year, you have to be focused on diversifying your funding sources and your investor base.
Hiseman, Morgan Stanley: We are still in diversification mode. Many corporates feel that even if they haven’t accessed a particular market for a while, they want to put a fresh benchmark out to maintain their presence in certain markets. The euro market has got more competitive in pricing and the basis swap to sterling is more favourable than it was, so we’re seeing some names tap that market. The only issue is that there is a price to pay to put the hedging in place. Over the past five years the hedging costs have got higher as banks charge more for their credit line. Treasurers are carefully weighing up what their preferred currency to fund in is. They want to limit the amount of hedging needed to do on the back of their debt financing, and the way to do that is to go directly to the currency they need rather than using swap derivatives. People are trying to focus their borrowing tactics around that.
Seibel, RBC: They are still in diversification mode, but not at any price. With increased regulatory pressure and pricing pressure on the derivatives front, borrowers are looking at the all-in cost. It’s a much more holistic view of funding mix and balance sheet structure than it was in the past.
Patel, William Hill: We’ve come through the credit crunch and our firm has performed relatively strongly for a consumer facing business. We’re now in the phase where the board is keen to progress with a growth agenda — we have some organic growth opportunities looking at the online sector, but we’re also looking to grow by acquisition. Clearly from a company point of view, part of my job is to make sure we have access to the funding required in order to implement the board’s growth agenda. It’s not just about diversification any more — it’s also about having access to funding from every source. That might be through turning to the bank market for bridge loans or through tapping the bond market. We’ve also gone to our shareholders for funding — we’ve done a rights issue to finance some of our acquisitions. So it’s using all the resources available to us to access liquidity.
Birgbauer, Jaguar Land Rover: Being in the cyclical auto industry, our strategy for funding is to maintain long term funding and strong liquidity, cash and undrawn committed bank lines, to support our funding requirements through the business cycle. It doesn’t really change depending on what the economic situation is at the time — we always want to have in place that kind of financing strategy.
EUROWEEK: Is UK plc still in recovery mode or has 2013 seen it turn a corner?
Birgbauer, Jaguar Land Rover: The auto industry in the UK has been performing pretty well for a while now, and the broader economic data particularly in the last couple of months has been strong. So the outlook does look more optimistic.
Seibel, RBC: The UK as a whole seems to be more in recovery mode now, and that is making its way through to corporates as well. Over the crisis, more jobs have been created in the private sector than were lost in the public sector, so I’m not so sure that UK plc was in as much trouble as the UK government. There is a growing degree of confidence, but people are not forgetting the still recent memories of what’s happened in the market. The events in June, when the markets wobbled with the expectation of the end of the tapering in the US, showed issuers that they still need to be on their toes and need to be flexible about what they want to do.
Kilonback, TfL: There are certainly signs that the economy is beginning to pick up — this is particularly true in London, although the capital does seem to outstrip the rest of the UK economy. Clearly, as a business we are very dependent on the strength of the London economy and on the growing population of the city. The London population has expanded much more rapidly than anybody expected — it’s about 600,000 higher today than it was expected to be at the time of the last census in 2001. With that population growth there’s an expected increase in jobs to go with it, and that’s really key for us. I get the feeling that London is performing far ahead of the rest of the UK, but while conditions remain quite hard, there are signs of optimism for the rest of the UK economy. Manufacturers are becoming world leaders again and we’re beginning to export goods to the rest of the world as well.
Pitt, Network Rail: If you look at the economic data that’s coming out it has been more positive and growth forecasts have been upgraded. We are seeing signs of recovery, but it’s still early days.
Patel, William Hill: I think we’re moving in the right direction. There’s improving news coming out of the economy that gives people confidence. But treasurers are still concerned that there could be another wobble in Europe, another geo-political problem or a slowdown in Asia that might affect the markets. Those things do give us cause to not be quite as gung-ho as we might have been. But in the UK things are starting to turn a corner, and that does give people confidence.
EUROWEEK: How important is it still to maintain a fortress balance sheet?
Kilonback, TfL: People are still fairly cognisant of how difficult it has been and at the moment they will feel more comfortable having a higher amount of cash available to them on their balance sheets. They have experienced difficulties in obtaining or renewing bank lines in the past.
Birgbauer, Jaguar Land Rover: Given that the auto industry is cyclical, auto companies tend to maintain relatively high liquidity levels compared to companies from some other sectors. We continue to believe that we need to maintain a strong balance sheet with long term funding, strong cash balances and good undrawn committed liquidity facilities. That doesn’t change depending on what part of the economic cycle we’re in.
However, this doesn’t mean we aren’t investing in the business. We are investing significantly to continue growing the JLR business. A strong balance sheet helps give us the confidence to do this.
Admans, BP: Clearly most corporates still think that cash has a strong value on the balance sheet. Before the financial crisis, cash on the balance sheet was considered an underperforming asset. Many corporates were put under pressure to return cash to shareholders because cash seemed to be only measured against return on capital. In the US there have recently been some bond issues linked to share buybacks, but there is not the clamour that existed in the mid-2000s to return cash to shareholders. Equity investors remain cautious over corporate debt liquidity and so are tolerant of high cash balances.
Patel, William Hill: I think we’re more confident than we were a few years ago during the depths of the downturn, but I wouldn’t say we’ve gone back to pre-crisis levels. I think that’s reflected by the attitude of investors. Given our position in the betting and gaming sector, we’re a very cash generative company. Before the credit crunch, our shareholders were very happy with our leverage of 3.5 times net debt to Ebitda, and some suggested we should take it north of there. Those same shareholders now would be horrified if you suggested leverage of that level. People have been scarred by their experiences with companies with balance sheets that were not as rock solid as they might be, so there is an element of caution. But it’s not as bad as it was. We’ve increased our leverage significantly to undertake acquisitions, and other companies in other sectors have done similarly.
Seibel, RBC: There’s a conviction sneaking through that this isn’t a little blip, but that we’re at the beginning of a more sustainable, modest economic recovery. So strategic initiatives are moving higher up in the priority list, rising above the need for fortress balance sheets that was a critical priority in late 2008 and 2009. It is a fine balance for most companies. There’s definitely more of a focus on financial planning, balance sheet management, liquidity, financial flexibility than there was in 2006 or 2007. If the M&A bankers go to discuss opportunities with corporate clients, one of the first questions is ‘how will this affect my balance sheet?’ The balance sheet is important, but borrowers are beginning to take a more balanced approach than before.
Hiseman, Morgan Stanley: There’s still an element of cautiousness around borrowers’ approach to their balance sheet. People are still in the mode of prefunding. A few corporates were scarred in 2008 when they had bridges out that they needed to refinance, and the markets ran away from them. In some instances rights issues had to be done to repair the balance sheet. I think most borrowers really understand that they have to make sure they are ahead of any upcoming maturities. Having an evenly tuned maturity profile is a priority for them. So I don’t expect to see corporates move away from that cautious approach. With rates still at an attractive level for them and only expected to go in one direction from here, borrowers are more willing to put in longer duration debt and keep it fixed.
Ramzan, Lloyds Bank: One of the defensive plays for any corporate is the amount of cash it holds. Now, cash and cash equivalents by FTSE 100 companies has hit £166bn, up from £42bn from 2008. That’s a lot of cash. But there’s been a shift recently. People are much more comfortable, and a little more confident in terms of the outlook. Banks are signalling that there’s more liquidity available in the lending market. There’s a shift to expansion strategies and according to surveys nearly half of CFOs are much more comfortable looking ahead and taking more risk on to their balance sheet. All the indications are that UK plc has turned a corner, but the key question is whether M&A will follow.
EUROWEEK: Do you think there’s increased confidence to use that cash on balance sheet?
Admans, BP: The market does seem settled with high cash balances but this could change if global economies start improving. Then treasurers will increasingly face questions about why they’re sitting on cash earning near 0% (in the US), when the return on capital from using the cash elsewhere (for example, acquisitions) would probably be far greater. Treasurers still remember the extreme liquidity crisis of five years ago and even now corporates still have the odd blip in liquidity. The euro markets can still be shut down for a month if there’s a crisis. There’ll always be a limit to the amount of cash shareholders will tolerate on the balance sheet in the long term, but for now the liquidity function of cash dominates.
Hiseman, Morgan Stanley: The majority of companies are maintaining comfortable cash balances and aren’t becoming aggressive in the way the balance sheet is positioned. But I would say the frequency of discussions about potential M&A deals has increased, and we’re talking to more people about deals than we have been for a while. When you see a big deal like Verizon Communications’ hit the tapes, it suddenly wakes a lot of people up to the possibility of jumbo financing. A deal like this is a huge positive for the market — it’ll give people a lot of confidence, and it’ll raise board rooms’ interest in the bond markets. Treasurers have been on the conservative side over the last few years since the financial crisis and the concern they’ve felt over their access to markets. Jumbo events like the Verizon deal may get people to look at M&A, but they’ll do that from a position of balance sheet strength having had a cautious initial approach to the market.
EUROWEEK: How do borrowers manage their funding strategy to navigate the uncertain interest rate environment?
Ramzan, Lloyds Bank: Those companies that have very publically talked about bottom fishing and trying to get in at the lowest point in the cycle are feeling reasonably smug. They can see that Gilts have risen by 125bp over the last year. Interest rates are historically low and are expected to be low over the rest of the year but then who knows. A lot of people have had their cake and they’re eating it.
Kilonback, TfL: As an organisation we plan over a 10 year horizon, so we tend to base our borrowing strategy around those plans. Because we have that fixed funding envelope, it’s important for us to get some certainty — knowing that we’ll need to do that incremental borrowing over planned period. For example, for our recent bond deal we brought forward some of next year’s planned fundraising because we felt that it was better to lock in 20 year money at today’s rates rather than waiting to get it done next year.
Pitt, Network Rail: I wish I had a crystal ball! No seriously, we are a regulated utility, we have a government guarantee of our debt and get the majority of our revenue from the UK government as well. So we tend to be more of a fixed rate issuer as that gives us more certainty. We can’t afford to have any shocks in our cashflows as a result of interest rate changes. We do a lot of interest rate risk management — we look to pre-hedge a certain proportion of future interest rates to match our needs, but you never know over the long term whether you’re going to get it right or not and whether rates will go up or down. The markets currently are extremely volatile and the interest rate risk is asymmetric.
Seibel, RBC: On May 2, 10 year UK government yields were at 162bp, and in early September they were at 3% — they’ve basically doubled. That’s clearly had a big impact on people who fund themselves in fixed rate, and a lot of companies have a relatively large proportion of fixed rate debt. Some may look at switching more into floating, because if you look at Libor over the same period, for example, it has gone up by only 2bp. These are the sort of debates that are becoming more active within treasury teams —how do you manage your fixed floating mix in a lively interest rate environment?
Admans, BP: We look at interest rates and liquidity separately. Our first concern is making sure that the company is liquid and has the required cash available, and the second is managing interest rate risk. As we are lowly geared our interest risk is low which has enabled us to have a bias towards floating rates as fixed rate costs are typically higher than for floating rates.
Birgbauer, Jaguar Land Rover: It’s difficult to know with certainty what will happen with interest rates. The market expects interest rates will rise going forward. In any event, treasurers need to look ahead at what their funding requirements are and try to have a funding plan over some time horizon. You want to try to access the market opportunistically when the market’s relatively more favourable over the time horizon but I think what’s most important is to stay ahead of the curve of when funding is actually needed.
Patel, William Hill: The Bank of England has said that the base rate will remain low for an extended period, but the markets think that rates will have to rise sooner than that and this is reflected in bond yields.
As a company, we’re generally quite risk-averse, so we tend to have a greater proportion of fixed interest rate debt. That does mean that we may not be paying as cheaply as we might, but it enables us to sleep at night. Financing is there to support the business, so as long as we think the business can generate the profits and we can fix the cost, we know everyone’s happy. Ultimately when I look at the cost of financing, I’m only concerned about whether I can afford it — it might not be the cheapest cost I could have got, but if the company can support it without putting pressure on the business we can concentrate on growing the operational and commercial aspects of the company.
Hiseman, Morgan Stanley: Many corporates tend to compartmentalise their need for liquidity and their interest rate exposure and manage both things separately. We feel pretty confident that credit spreads will remain fairly middle of the range, around where they are now, as there’s nothing to suggest that corporate defaults are on the rise. The real risk for borrowers is the underlying benchmark and government yields moving higher, pushing borrowing costs higher. Many borrowers pre-hedge against that risk, and many of our clients are pre-hedged for longer periods into the future than I’ve ever experienced. Borrowers have been pre-hedging for three or five years ahead. Providing you can point to a maturing piece of debt, it’s a good thing to execute that pre-hedge.
Other borrowers don’t like the pre-hedging approach and pre-fund instead, although that’s less efficient as you have a cost of carry associated with the cash sitting on your balance sheet.