UK blue chip corporates have a wealth of opportunity in the bond markets. They can find a receptive audience at home in sterling — or overseas in dollars or euros — in almost any maturity they require. Pricing was already tight but now banks are keener to lend too, providing alternatives to the bond market.
For UK investment grade issuers in sterling and euros, what Farouk Ramzan, managing director and head of capital markets origination at Lloyds Bank, calls “a perfect storm” set in last year.
That storm consisted of lower competing supply from bank issuers and a stronger bid for safe haven assets from sovereign debt crisis-scarred investors in a market where rates were low.
One year on, there are some differences, but the atmosphere remains positive. “We’re certainly continuing to see extremely favourable conditions for UK investment grade corporates,” says Marcus Hiseman, head of European corporate debt capital markets at Morgan Stanley. “For the top blue chips, with large balance sheets, which are still generating robust cashflows, they are definitely still in high favour with investors.”
Last summer Morgan Stanley was one of the leads on the lowest coupon in corporate history for Unilever, which paid 45bp and 85bp respectively for three and five year bonds. “This year we are not getting the lowest coupons, but still huge deals are being done with the same level of order books,” Hiseman adds.
However, the prospect of quantitative easing (QE) tapering in the US drove a $110bn net outflow from US bond mutual funds in May alone, and £7bn of net outflows from UK bond funds in June, suggesting the long-expected great rotation from bonds to equities may be underway.
“We’re sitting on that cusp right now,” says Christoph Seibel, head of corporate DCM for Europe at RBC Capital Markets.
Issuance levels are lower to match. UK investment grade corporate issuance in sterling is down by 39% year on year, and euros 13%.
Investors are also being more selective about which credits they buy. “It’s the same investors as a year ago, but whereas then there was almost an indifference in terms of credit fundamentals, now you can see them being more disciplined in picking the credits they really support,” says Hiseman.
That said, the Federal Open Markets Committee’s announcement in mid-September that it will not be decelerating QE at the rate many expected could change things again. ”Many borrowers might see it as a renewed opportunity for financing in this lower interest rate environment,” says Nicholas Denman, managing director, investment grade finance at JP Morgan.
Deep dollars
The dollar markets remain the most popular location for borrowers because it offers the biggest deal sizes and the quickest access. “The quantum of money available means drive-by deals can be done very quickly in the dollar market,” Ramzan says. “The perception is you get deals done in a safer environment there.”
In February Vodafone raised $6bn in a five tranche deal, covering three to 30 year durations, in April Diageo took $3.25bn with a $10bn order book, again at three to 30 years and there have also been other large deals from the likes of BP, GlaxoSmithKline, Rio Tinto, Imperial Tobacco, AstraZeneca and SABMiller.
In 2009, Ramzan says, 42% of all UK corporate bonds were in sterling, compared to 25% in 2013 year to date, while the share in dollars have grown from 38% to 51% over the same period.
One sticking point for some European issuers to accessing the US market can be the onerous amounts of documentation required but this has not been such a hindrance to UK borrowers.”Many of them have operated in the US for a long time and are already following US regulation anyway,” says Seibel.
And the appetite for UK names in the Yankee market is redoubtable. Much of that has to do with the fact that so many UK-based multinationals run businesses that operate predominately on dollar cashflows or have big operations in the US that need financing. Or, like the oil companies, they are involved with a product that trades in the currency.
“What amazes me about the Yankee market is the ability for the oil majors to come back time and time again every three to six months,” says Hiseman. The BP trades are a classic example. “They have done a phenomenal job, rationing their visits to two or three a year, and printing what investors like: a predictable and regular supply of bonds refreshing the curve and keeping benchmarks in the market.” It’s perfect, he says, for index followers and for big money managers who want liquid names to be able to trade.
Euros, oddly given that the EU is the UK’s biggest export market, seem to have missed out. Seibel says that year to date, 55% of issuance by investment grade UK corporates has been in the dollar market, 23% in sterling but only 18% from euros. This has had to do with the relative pricing on offer, which has made euro issuance unattractive to UK firms, although there are signs now that medium maturities in euros are offering more compelling levels.
Many recent euro deals have been successful and interesting, often combining a euro tranche with another in sterling. NGG Finance, for example, the borrowing entity for the UK’s National Grid electricity and gas transmission company, sold €1.25bn of 60 year, non-call 7.25 paper and £1bn of 60 year, non-call 12.25 paper in March — the company’s debut in the hybrid market. In December, Rio Tinto combined euro tranches of €750m and €500m in seven and 12 year funding respectively, with one 17 year clip of £500m.
Whereas a handful of institutional buyers dominate the sterling market, the euro market offers a far broader range of investors and in bigger numbers. “In a sense, you get better execution and price discovery because you are using a larger number of investors to distribute the bond through,” says Ramzan.
However, with its sharp pricing, the bond market is not the thing that is stopping greater issuance levels. The swap market, used to exchange proceeds of the bond into a required currency and to hedge interest rate risk, has become more expensive as a result of bank regulation meaning borrowers save money overall by avoiding cross-currency swaps, even if they pay a few extra basis points on the bond itself.
Long term
Being dominated by pension funds and insurers means there is plenty of term funding on offer. And with rates so low, investors are looking further along the curve for yield.
“The volume of 20 year tenors and over account for 70% of total sterling issuance for UK corporates this year, up from 44% last year,” says Ramzan.
Sterling also offers borrowers a better chance of picking an exact maturity to suit its needs rather than the standard five, 10 and 30 year benchmarks available in say, dollars. Arqiva, which raised £750m in two tranches — one with 22.3 years duration, the other, just under 20 — in February, and High Speed Rail Finance 1, which raised £760m in 25.7 year funding two weeks earlier, and a GlaxoSmithKline £1.4bn deal, some raised in 33 year money in December, all exemplify that point.
But not every issuer is able to take advantage of those characteristics. The lack of investors gives them a bigger say in pricing and not every borrower needs long dated debt. Also, UK borrowers do not always need sterling and although they will be comfortable raising cash in their home market, they will be put off by the cross-currency swap costs of converting the proceeds into another more useful currency, which are especially high for the sort of long dated deals characteristic of the sterling market.
But there may be opportunities outside of the three main markets. Australian and Canadian dollars “are much overlooked markets by UK corporates,” Hiseman says.
Seibel adds: “BHP, National Grid and BP have all branched out into Canadian and Australian dollars. That approach — looking for further diversification, adapting to different market environments, looking at the capital structure in a holistic context — is a constructive and positive development of the UK market.”
Loan market fights back
And, increasingly, there are loans on offer. “In the last 12 months we have seen a significant increase in the number of participants in the market, which means there has been an increased level of liquidity, and pressure on pricing and structure,” says Simon Allocca, head of loan markets at Lloyds Bank, who has seen a reduction of around 12bp on undrawn pricing for investment grade UK corporates.
That has consequences for the bond market. “If you are able to get that kind of pricing and liquidity, we go back to the dynamic of 2006, where people take cheap loans and don’t need to go to the bond market,” says Allocca.
At first glance, the market does appear to be moving back in that direction. Ramzan says that last year, the ratio of European funding shifted towards something resembling the US, where debt capital market funding outweighs bank lending: it moved to 57% bonds, 43% loans. “But this year it’s gone back the other way: 48% bonds, 52% loans.”
But bond bankers will be keen to remind corporates not to use up all of their loan facilities just because the pricing is cheaper now, and instead use the bond market to leave some room for bridge loan financing when the firms need it.
Seibel notes that the longer term trend has been for the percentage of bank lending versus other forms of debt capital to decrease as a result of the financial crisis and the deleveraging of banks.
“But the large scale corporates don’t have problems raising bank funding, because they are the ones with the greatest global reach and the biggest ancillary fee pool,” he says. “Banks clearly think: if I give a dollar to one of those blue-chips, the hope that I can earn equity underwriting or FX fees is larger than with a small SME that only operates in the UK. The availability of bank credit to those companies remains very strong.”