Promising new patterns in debt markets

The year 2014 is set to be a significant one for the global debt capital markets (DCM). Underwriting banks have been powering ahead in the first nine months, driven by issuance from financials and speculative grade-rated companies. And 2015 should not be much different – unless the cycle or rate environment takes an unexpected turn.

Low rates have made refinancing exercises cheaper and more attractive, pushing DCM new issue activity for the year to $4500bn by the end of September, according to data from Thomson Reuters, making the first nine months of 2014 the strongest since 2009.

“We are up in DCM volumes compared with last year,” says Hakan Wohlin, global head of debt origination at Deutsche Bank. “There is no doubt that at some point a less accommodative Federal Reserve means higher short-term rates and a flattening yield curve, but the timing of that might be slightly later and the magnitude might be less than previously expected.”

New trends

Financial companies have been the powerhouse of the first nine months of 2014, accounting for nearly 50% of all DCM activity – a 40% rise in supply over the year.

“While we have seen wholesale financing from banks going down, the same regulation that is forcing banks to rely more on deposits in the financing of the balance sheet and less on senior and covered bonds is asking banks to raise much more capital; not only core equity but also subordinated capital – additional Tier 1, Tier 2,” says Demetrio Salorio, global head of DCM at Société Générale Corporate & Investment Banking. “This year we have seen phenomenal growth, especially in additional Tier 1, with many new names launching transactions – a trend that will continue into 2015.”

Hybrid capital has also been a trend in the corporate bond market. As the economic environment put some pressure on corporate ratings, hybrids emerged as an effective instrument for investment-grade corporates to raise debt, while defending the senior ratings of the institutions.

“It’s been another record year of supply, and hybrids that five or six years ago were only used on a case-by-case basis, now are mainstream,” says Mr Salorio.

Meanwhile, the high-yield bond market is trending towards another record year in Europe, with issuance expected to reach about €100bn. High-yield bonds, traditionally very strong in the US, are developing more and more of a cross-border relationship thanks to a growing European issuer and investor base.

“The US market is €230bn to €240bn equivalent, so the European market is already trending towards half of the size of the US market,” says Mr Salorio. “Which is quite amazing, when you keep in mind that only in 2008, the total supply in European high-yield was zero.”

European issuance was up 44.4% year on year by the end of September, according to Reuters, driven by deals such as the largest ever high-yield bond offering, which was by French telecommunications company Numéricable Group. The €11.64bn equivalent bond financing included both euro and dollar tranches and financed the leveraged buyout (LBO) of French telecoms firm SFR by French telecoms investor Altice through Numéricable (its portfolio business).

Elephant in the room

LBOs and mergers and acquisitions have started to see a revival in 2014, a development that Mr Wohlin expects to continue. “While there are growth concerns in Europe, we have seen, in the past two months, five German acquisitions into the US to buy companies to support future growth, which were partly debt financed,” he says. “At these historically low rates, the calculations look attractive.”

Mr Wohlin sees additional growth potential in emerging markets, which contribute 52% to the world’s gross domestic product, while accounting for 80% of economic growth globally.

After a few days of risk-aversion in mid-October, however, some question marks emerged over the market going forward. “The big elephant in the room is: is there going to be a change in the cycle?” says Mr Salorio. “There is no event that is changing the sentiment, but investors are starting to realise that growth is not as strong as they were expecting, the monetary policy response to the current situation in the US is very unpredictable and we have seen a couple of days of de-risking [in mid-October].”

Banks have less capital available on their balance sheets to support the market compared with before the financial crisis, which means that should there be a general change in sentiment, and investors continue selling their holdings, there could be increased volatility going forward. “It’s unchartered territory,” says Mr Salorio.