Despite being dismissed by forex traders when it was launched five years ago, last year the euro became the dominant currency in bond issuance, says Edward Russell-Walling.
It wasn’t very long ago that forex traders, nursing losses, were rudely dismissive of the euro. Whatever the vagaries of the foreign exchanges, in the capital markets, the new currency has triumphantly come of age. In 2003, for the first time, there was more international bond issuance in euros than in dollars, a trend that seems likely to continue, even though this year’s volumes have been disappointing. Last year’s euro-denominated international issuance totalled €988bn ($1113bn), according to figures from Thomson Financial, against dollar-denominated proceeds of $898bn. Though the euro deals were of smaller average size, there were considerably more of them – 2316 compared with 1333 dollar issues. There were specific influences swelling these numbers, notably a refinancing spike as early euro issues approached maturity. More than anything else, however, they represent a cultural step-change, as Europe’s corporate borrowers increasingly embrace the capital markets and its investors develop their appetite for corporate paper. Five years on The single most important historic driver, of course, was the 1999 launch of the currency itself. Until then, the dominant single currency in the Eurobond market was the US dollar. “Since the euro came along, we have seen a more consolidated core of liquidity in Europe,” observes Morven Jones, managing director debt capital markets at Lehman Brothers. “Because of that, the euro now rivals the dollar in international bond finance.”
Morven Jones: euro rivals the dollar Other drivers are only now gathering steam. One is the part-push, part-pull that is propelling corporates out of traditional bank borrowings and into the debt markets – the same process of disintermediation that has already been seen in the US. “If banks are getting good returns, they are happy to keep the loan,” says Zia Huque, head of Europe and Asia Pacific syndicate at Deutsche Bank. “But they’d like to move the less profitable ones into the capital markets.” Companies may be pushed by commercial lenders, but they are also drawn by the attractions – pricing, not least – of the capital markets themselves. “There is enormous liquidity in this market,” Mr Huque points out. “And since it is prudent for corporate treasurers and CFOs to diversify funding sources, they are increasingly looking at the capital markets as one of those sources.” Long-dated CFOs are also attracted by the longer-dated tenors available in the bond markets. “Aggressive bank terms go out to perhaps five years, but you can get 10 to 15 in the corporate space – and up to 30 for selected credits,” says Mr Huque. He adds that the comfort level of European corporate finance staff vis-a-vis the corporate markets has grown exponentially in the past three years, and this too has had its effect on volumes.
Zia Huque: capital markets aid diversification Cheap bank loans are even less likely to be on tap as the Basel II risk capital provisions start to bite. In the German market, that effect will be compounded next year, when the Landesbanks lose the government guarantees that have allowed them to lend so competitively. Indeed, Germany is regarded by some as Europe’s most promising growth market for corporate debt, though they would acknowledge that it is still early days. Once the long-awaited process of bank consolidation starts to take hold – in Germany as in other continental markets – this too will accelerate the migration to the bond and equity markets, believes Ruediger von Rosen, managing director of Deutsches Aktieninstitut, a German capital markets think tank.
Ruediger von Rosen: Basel II will speed things up “Basel II will make things move faster in this direction,” Prof Dr von Rosen emphasises. “Its principle of different risk classes and different premiums means that there is already a better understanding of the risk-capital approach. And as bigger banking units develop, they will be looking to market their capital market activities more aggressively.” Growth in supply goes hand in hand, as it must, with growing demand. “Many investors prefer, or require, a less volatile return profile than that offered by equity-based asset classes,” says John Winter, Barclays Capital’s head of European investment banking and debt capital markets. “Generally speaking, bond markets are less volatile than equity markets.” Pension funds, for example, have been looking at alternative asset classes to equities, Mr Winter says. Like many others on the buy-side they are developing more in-house credit skills. “Increasing investment in research, credit analysts, and benchmarking methodology has led to a much more sophisticated investor community,” he says. Bur the US dollar market is still alive and well in Europe, Mr Winter acknowledges. “Many investors buy dollar issues because it suits their business mix and preferred currency profile. Among Swiss investors, for example, there’s continued interest in diversifying currency exposure. But growth in the dollar market has slowed relative to the growth in the euro market in Europe.” There is also, he adds, growing interest in the euro from outside Europe. Asian central banks, for example, are moving some of their foreign exchange reserves into euros. “They want stable, diversified reserves,” Mr Winter says. “Given the volatility in the dollar, that’s sensible.” Trend set to continue In this environment, most bankers agree that the euro’s rise will continue. “It’s difficult to get specific numbers, but two-thirds or more of US corporate funding is done in the capital markets,” says Deutsche Bank’s Mr Huque. “In Europe it’s less than 25%.” That said, 2004 is turning out to be as lacklustre as 2003 was sparkling (to everyone’s surprise). Corporate issues across the board are down by as much as 40%, spreads remain tight, and few expect much improvement before year’s end. That’s partly a reflection of a busy 2003. “Because of the strong market conditions, quite a lot of issuers did their 2004 funding in 2003,” says Mr Jones. Corporate borrowing is at muted levels, quite apart from that. The borrowing peaks of 2001 and 2002 were followed by a period of balance sheet restructuring, much of which is now complete. Mergers and acquisitions activity is quiet, and what deals there are have tended not to use much debt. “Capital expenditure is picking up, but our view is that this is often funded out of internal resources,” says Mr Jones. “So the overall need for funding is low.” There are some bright patches. One is in high yield, where many newcomers to the bond markets make their debut. At $16.7bn, issuance to end-July has already outstripped last year’s total of $15.5bn, according to Goldman Sachs, and the full year could topple the 1999 record of $17.7bn. Last year’s B1/B+ €2.55bn issuance for fallen angel Vivendi Universal illustrates the potential of this market. More recently, Italian directories company Seat successfully issued €1.3bn of high-yield paper. “Eighty per cent of high yield market deals for European companies are now non-dollar, and the lion’s share of that is in euros,” says Mathew Cestar, executive director, high yield capital markets at Goldman Sachs. “The shift away from reliance on the US-dollar market for European issuers is an indication of the health of the European market.” The search for yield has broadened institutional horizons in recent years. And the sectoral, geographic and ratings diversity of the companies now tapping this market, Mr Cestar says, has given investors the confidence to allocate money to it. “Pension funds and insurance companies were reluctant to invest in what was historically a highly concentrated asset class,” he points out. “The present diversity in high yield makes it more attractive to a broader investor base than ever before.” Asset-backed securities Asset backed securities are also enjoying the sunshine. In the first quarter of 2004, the European securitisation market grew by 26% year-on-year to €54bn, according to the European Securitisation Forum. And Deutsche Bank believes that bond market securitisation volumes will exceed investment grade issuance in Europe for the first time ever this year – which says as much about the state of the latter market as of the former. “Asset backed securities are among the fastest-growing parts of the market” says BarCap’s Mr Winter. “New issuers and investors are entering the market on a regular basis. Some companies find it is the most attractive way to get financing, whereas investors find the return profiles compelling.” Floating rate notes (FRNs) are bringing some cheer to the investment grade market. As Lehman’s Mr Jones puts it: “With the expectation of rising interest rates, investors are looking for a more defensive instruments than fixed rate products. So FRN issue volumes have surged relative to fixed rate.” Investors, he adds, are now prepared to buy FRNs with maturities longer than the traditional three to five years. “We have seen a lot of issuers extend to seven years and some to 10.” The recent €500m 10-year FRN (at 10bps through the level achievable in the dollar market) by General Electric Capital Corporation, GE’s financial services arm, is a case in point. Yet another theme has been an upsurge in so-called liability management, with companies taking advantage of market conditions to retire or extend debt through tender or exchange offers. Engineering company ABB, for example, recently offered to buy back €775m of bonds maturing over the next two years. “We are seeing an explosion of liability management exercises from those unwilling to sit on their hands,” says Eirik Winter, Citigroup head of corporate debt markets.
Eirik Winter: explosion of liability management He admits that this is proving a tough year in the corporate sector. “So we are trying to think laterally, to be innovative. We are looking at new products such as hybrid capital, and co-operating with our equity people to look at the convertible bond market.” Like most of its peers, Citigroup is not making any great effort to hire at this end of the business right now, nor to fire. “We’re investing and consolidating in a difficult time,” says Citigroup’s Mr Winter. “We’ll be there when things come back – but whether that’s in two months or two years, I just don’t know.”
