Glory days for corporate market

Europe’s corporate bond market could hardly have begun the year with more of a flourish. Following a hesitant finish to 2011, when the eurozone’s woes caused investors to all but retreat from its bond markets, there was a flood of issuance of corporate paper in January. In the euro market, some €20bn of investment grade bonds were printed, while the figure was about £6bn (€7.18bn) for the sterling market.

This was a far quicker start to the year than bankers and analysts had expected – strategists at Société Générale had forecast there would be €95bn of euro deals and £16bn of sterling ones during the whole of 2012.

Boom time

Such has been the demand for corporate bonds in Europe that borrowers raising huge order books have ceased to raise eyebrows. “I can’t remember a time where you would launch a €1bn corporate deal and get €5bn of orders on such a regular basis,” says Roman Schmidt, head of corporate finance at Commerzbank.

Moreover, corporate borrowers have not had to offer burdensome yields to get investors to buy their debt. Coupons of less than 4% for five-year paper are far from unusual for companies rated BBB or higher. Blue-chip borrowers, especially those from northern Europe, have been able to fund particularly cheaply. BMW printed a £750m seven-year bond in late January that had a coupon of just 3.375%. “Corporate borrowers aren’t just getting deals done. They’re getting them done at all-time low coupons,” says Nick Bamber, head of investment grade corporate bond origination at Royal Bank of Scotland.

Demand has not been confined to issuers from northern Europe, however. Those from Italy, Spain, Portugal and Ireland had struggled to tap the market in the second half of 2011 amid mounting concerns about their sovereigns’ debt and the health of their local banks. But a €750m seven-year note from Repsol, a Spanish oil company, on January 12 opened the market for peripheral eurozone issuers. It was soon followed by a €500m deal from building materials group CRH, the first corporate bond from Ireland since its €85bn bailout in November 2010.

Even more notable was Italian oil company Eni’s €1bn eight-year deal in late January. It garnered a massive €11bn of orders from 525 investors. “I’ve not seen an order book with 525 orders for a long, long time,” says Jean-Marc Mercier, global head of debt syndicate at HSBC, one of the bookrunners on the bond.

Backlog building

The large supply of corporate paper in January and early February was partly a result of some borrowers having been unable to issue in late 2011. A backlog had built up, say bankers.

The pipeline became even more crowded as some companies that were originally going to wait until later in the year brought forward their funding plans. “Some borrowers didn’t intend to tap the market until March or April,” says Pascal Bay, head of European corporate debt capital markets at Bank of America-Merrill Lynch. “But conditions were so attractive at the beginning of the year that they decided to issue early.”

This thinking showed that borrowers were still cautious with regards to funding and wary that the bond market, for all its robustness early in the year, was liable to close rapidly later on should the eurozone crisis deteriorate suddenly. “Issuers are still facing a lot of uncertainty,” says Mark Lewellen, head of corporate origination for Europe, the Middle East and Africa at Barclays Capital. “Their primary concern is making sure they have adequate liquidity to cover capital expenditure or maturing debt. There’s a sense of: ‘Let’s get our funding done now rather than wait on the basis that the market might get even better.’”

Investors for their part were encouraged by the European Central Bank’s decision in December to provide unlimited three-year funding to banks. The longer-term refinancing operation (LTRO) made them confident that eurozone lenders would have few difficulties refinancing their debt over the next few years and led them to start hankering for deals again. It also had the effect of boosting liquidity in all bond markets, including the corporate one.

“The corporate bond market changed considerably between December and January,” says Jonathan Brown, head of European bond syndicate at Barclays Capital. “The LTRO in late December provided unlimited liquidity and showed that the ECB was ready to take significant action. It provided confidence as well as money, and we have seen a significant amount of that cash reinvested in the primary markets.”

Fundamentally sound

The main reason for the market’s rude health, however, is the strength of corporate borrowers’ credit fundamentals. Prior to the onset of the global financial crisis, non-financial companies were viewed by investors as collectively riskier than financial borrowers and sovereigns. Yet many now have the status of safe-havens, thanks to the resilience of their cashflows over the past three years and their low levels of debt. Exemplifying this, blue-chip companies from Spain and Italy have over the past 12 months regularly issued bonds that yield less than those of their respective sovereigns, as was the case with Eni’s €1bn deal.

Corporate borrowers’ underlying strengths have not diminished, in the eyes of investors, in the past six months because of the performance of the eurozone. Rather, most investors have seemingly been reassured by the resilience of the bloc’s main economies and by most of their leading companies continuing to report high demand for their exports. “The perception in the fourth quarter of last year was that Europe would enter a large recession that would engulf both France and Germany,” says Commerzbank’s Mr Schmidt. “That hasn’t materialised. The European economy is performing much better than had been expected four or five months ago.”

Rating agencies are predicting low default rates for the foreseeable future. Moody’s said in January that it expects European junk bond default rates to rise only slightly from 3% between December 2011 and the end of this year. Default rates for investment grade borrowers should be even lower.

Recession-resistant

Bankers add that investors will continue to be sanguine about credit markets even if Europe’s economic slowdown is prolonged. They say that such a situation – particularly coming alongside low interest rates – might play into the hands of the corporate bond market and deter investors from putting their money into equities. “If Europe’s economic slump is a long one, the equity market will be a tough place,” says Mr Bamber of RBS. “But, amid growth of, say, 0% to 1% and low inflation, investors will be happy with corporate bonds returning 4%.”

As HSBC’s Mr Mercier points out, bond buyers care more about a company having stable cashflows and earnings before interest, tax, depreciation and amortisation than growing its profits quickly. “Credit and equity markets are different,” he says. “Bond investors just want to get their money back and paid adequately for the risk. They’re not concerned about whether a company will grow or not, unlike equity investors.”

January and early February’s hefty supply of euro and sterling corporate bonds is unlikely to be kept up for the rest of the year as many companies could look to complete the majority of their funding for 2012 by the end of the first quarter.

No bubble

Yet despite the expected slowing of issuance, bankers insist that the corporate bond market is not a bubble waiting to burst. Most cite low default rates and increasing demand from investors to argue that the corporate bond market’s buoyancy is a long-term trend.

It is one, moreover, that is being strengthened by borrowers’ attempts to diversify from the loan market. European companies have traditionally been far more reliant on bank debt than bonds, with most using the latter for only about a quarter of their funding before 2008. That has changed as new regulations are enforced making it more expensive for banks to provide long-term drawn debt, especially to borrowers without ratings of A or higher. Companies have thus increasingly found it easier to turn to the capital markets than the loan market when seeking term debt of five years or more.

“A lot of CFOs have put emphasis in the past two years on having longer term funding,” says Mr Schmidt. “That’s the appeal of the bond market. It’s what you pay a premium for. The idea of short-term volatility doesn’t really bode well with loans that typically have maturities of 18 months or two years.”

The consequence has been a marked shift in the debt profiles of Europe’s biggest firms. “If you take the top 100 European borrowers, we’ve gone from a situation two years ago where they had 50% to 60% of their debt in the form of bonds to 70% to 75% today,” says Bank of America Merrill Lynch's Mr Bay.

Analysts are largely confident this development will continue and that smaller companies will also start to issue in the capital markets more often, supported by a growing base of retail bond investors. As such, few believe the corporate bond market’s heyday will end soon.

A major unforeseen crisis in Europe, such as a break-up of the eurozone, could shatter that optimism and derail the market. But in the absence of such a disaster, corporate bond bankers see plenty of good years ahead.