Heavier capital requirements and tighter funding conditions for European universal banks have increased the importance of debt capital markets rather than bank loans for European companies. Morgan Stanley's co-head of global fixed-income markets is working to make sure the bank can seize the opportunity.

Think of Morgan Stanley, and the firm’s equity capital markets (ECM) and mergers and acquisitions (M&A) businesses tend to come to mind. The debt capital markets practice is normally regarded by outsiders as the poor relation within the bank, all the more so in Europe, where relationship lenders have historically dominated the bookrunner tables in their home markets.

There can be little doubt that the picture has changed in the past year. Barely among the top 20 bookrunners for European debt in the year to September 2011, Morgan Stanley entered the top 10 by the start of September 2012, according to Dealogic data. For high-yield bonds, the bank was even up to fifth, ahead of European debt giants BNP Paribas and Barclays.

The progress has been about quality as well as quantity, with the bank participating in many significant deals – the first sterling issue of 2012 for Dong Energy, the first ever 50-year deal for the Republic of Austria, and deals for four European banks that have helped revive the Tier 2 hybrid bond market despite uncertainty over capital regulations. Nor has Morgan Stanley shied away from issues in the difficult peripheral European markets, with deals for Fiat, Enel, Snam and Generali in Italy, and most recently for Repsol in Spain.

Taking its chances

The change in the global banking landscape is part of the reason, say Claus Skrumsager, promoted to co-head of global fixed-income capital markets (FICM) at Morgan Stanley this yea,r alongside Leo Civitillo in the US. Balance sheet has become a scarce commodity for European banks, hit by the double blows of Basel regulations and the eurozone sovereign crisis.

“We do lend and we have always maintained rigorous pricing discipline. We have never led with our balance sheet, always with best-in-class content and specialised knowledge for each client group. With all the new regulation and deleveraging, that has never been more important – financing is not straightforward to execute any more, the risk of pulled deals is there, and we have gained market share in these more difficult conditions,” says Mr Skrumsager, who was previously head of European FICM from 2009.

But Morgan Stanley has also made a very deliberate strategic decision to step up its FICM business in response to those changes in the market. The FICM team already had working relationships with corporate treasurers, and is co-operating ever more closely with investment bankers who cover the chief executives and chief financial officers (CFOs).

“We have a best-in-class distribution platform across rates and credit where we often rank as the top three liquidity provider in our clients’ securities. This is important to our clients at a time when they are concerned about how their outstanding securities fare in these volatile markets. And for the banks, funding has gone from being a routine task to something managed at the CFO level, it is now a strategic matter and that plays to our strengths,” says Mr Skrumsager.

Close co-operation

He is leading the drive alongside head of European corporate debt Marcus Hiseman, and head of European financial institutions group debt Philipp Lingnau. Mr Hiseman, who joined from Merrill Lynch in 2008, says he has experienced good co-operation between divisions at Morgan Stanley.

“We provide clients with the whole range of services from the beginning – M&A advice, bridge loan, bonds and risk advisory. That also means the FICM team is given the whole picture from the start and is able to advise on financing options and market conditions, not just brought in at the last moment for a bond deal,” says Mr Hiseman.

He also believes that the bank’s credit committee is nimbler than some competitors. The bank lent into the SABMiller acquisition of Foster's in 2011, and picked up the mandate for the subsequent $7bn bond to take out the bridge financing.

Similarly, Mr Lingnau’s team takes responsibility for financial institutions hybrid issuance and includes a number of equity specialists. It also works closely with the ECM team to be able to offer well-integrated advice and distribution capabilities for the whole of banks’ capital structure.

“We offer clients a global capital markets practice for a strategic dialogue on the choice of issuance, and the seam between debt and equity is vital. Two or three years ago, FIG was about rights issues, but now the equity market is not there and the Tier 1 and Tier 2 markets have opened up – we have been the thought leaders who helped reopen Tier 2,” says Mr Lingnau.

Yankee market dandy

The change in bank funding conditions is particularly significant, because many of the higher-rated corporates can now access capital markets more cheaply than their relationship lenders, making the loan market less appealing. Mr Skrumsager estimates that total European corporate bond issuance is up 70% year on year.

Issuance of dollar-denominated Yankee bonds is up 55%, as European corporates seek to tap the deeper and more liquid US market. That is especially helpful for a US investment bank, and Morgan Stanley topped the league table for Yankee bonds in the first eight months of 2012, according to Dealogic, with a market share of more than 11%. In addition, the bank’s joint venture with Mitsubishi UFJ in Japan helps access another investor pool for European clients, which Mr Skrumsager expects clients to tap increasingly over time.

With the eurozone sovereign crisis still unresolved, government and central bank policy decisions are critical to market conditions. Mr Skrumsager says Morgan Stanley’s highly regarded global economics team under Joachim Fels is also an important ingredient in the overall offering.

“It is not about making some sort of prophesies, but rather about providing real insight into how decision-makers are thinking, whether it’s the more than 20 European Central Bank governing council members, Italian or Spanish politicians. That analysis of the macroeconomic reality has never been more important for go/no-go decisions on deals,” says Mr Skrumsager.

Permanent change

Despite the challenges, he is prepared to state that he is fundamentally bullish on Europe – with the caveat that he hopes these are not “famous last words”.

“On a relative basis, many European assets are undervalued, and investors are moving into the market in greater numbers, with more realistic price expectations. Many banks have also strengthened their balance sheet, allowing them to take small losses on the sale of non-core assets such as commercial real estate or project finance that do not make sense for them to hold long term. So the price gap between buyers and sellers is narrowing,” he says.

But even if the eurozone situation improves, he is adamant that there will be no going back to the pre-crisis paradigm due to tighter regulation of risk and capital. That means the recent gains made by Morgan Stanley cannot be easily reversed by domestic relationship lenders.

“We are certainly seeing commercial banks refocusing their efforts on their domestic base and being relatively aggressive. But clients experienced some of their core banks stepping away or increasing borrowing costs during the worst moments of crisis, they learnt that it is critical to have alternatives to relying on an intimate banking relationship. So even corporates that have access to affordable domestic lending are coming to us to educate them on the alternatives,” says Mr Skrumsager.

Traditionally, the loan format accounted for as much as 75% of European credit markets. He estimates that this has already moved toward 50:50 loans to bonds, and that the trend will continue toward the US market model where bonds account for 75% of credit, due to what he calls the “force of gravity” from new regulation and deleveraging.

In fact, Morgan Stanley has been building out its capabilities in European asset-backed securities (ABS) since hiring Cecile Houlot from JPMorgan in 2010 as head of European ABS. This is not just about tapping into any revival of the European ABS markets – something that still looks distant – but also about having the expertise to advise on the deleveraging process.

Structured credit is very capital-intensive under new regulations, and therefore forms a substantial part of the outstanding non-core business that banks want to sell or restructure. At the time of writing, Morgan Stanley was leading a liability management exercise for Italy’s UniCredit that includes a buy-back of ABS issues.

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