Rising risk appetite floats peripheral boats

There is little doubt that the pledge by the president of the European Central Bank, Mario Draghi, in July 2012 to do “whatever it takes” to preserve the euro transformed the fortunes of debt capital markets (DCM) in the second half of the year. By the start of 2013, investor risk appetite had risen far enough to enable some peripheral eurozone sovereigns to re-enter the market or close deals on much improved terms.

Those included Spain and Italy’s respective €7bn and €6bn blockbuster syndicated issues, Ireland’s €2.5bn tap of its 2017 bond at a much tighter spread, and Portugal’s €2.5bn return to the bond market for the first time since its May 2011 bail out. Banks in all four countries – even second-tier issuers such as Spain’s Banco Popular – have also been able to access covered bond markets. Even in Greece, which had suffered pariah status since 2010, private company Hellenic Telecom managed an issue for €700m, although the yield was decidedly generous given that the company is 40% German-owned.

“Issuers had heard investor feedback that their offerings would be well received and responded accordingly with a rapid but orderly return to the market. The numbers are not so large relative to the size of the market and we are not getting carried away, but the environment in January was the best it had been for about two years. But it is not business as usual yet – sentiment can still change very quickly,” says Charlie Berman, head of Europe, Middle East and Africa public sector DCM at Barclays, which was bookrunner on all four deals.

Changing investor base

Indeed, sentiment changed quickly enough in early February to prompt bookrunners to pull several deals as pricing deteriorated. Richard McGuire, senior fixed-income strategist at Rabobank, believes a return to systemic crisis in the eurozone will remain a distinct possibility until there is an adequate framework for fiscal integration to match the monetary union. A scandal surrounding the Spanish government and the risk of political deadlock after elections in Italy in March 2013 could both trigger renewed volatility.

But there are signs of a sustained reappraisal by investors. Hedge funds were the first to start buying peripheral debt in the fourth quarter of 2012, and were able to book significant profits by the end of the year. Now the real money buyers are showing up.

“There is a broad and global investor base returning,” says Jonathan Brown, head of European bond syndicate at Barclays.

Investors from the UK are more involved, and the large-scale return of US investors to the eurozone for the first time since mid-2011 is a new component. The UK and US investors were not heavily involved in the eurozone peripheral markets pre-crisis, which may mean they have been less hurt and have more fresh funds to invest.

Rock bottom interest rates and the tightening of spreads in the second half of 2012 have prompted investors to seek higher yields once the immediate concerns about the sovereign-bank feedback loop had been assuaged by Mr Draghi. But with signs of investor jitters about the periphery returning, the search for yield is likely to return to corporate deals instead of sovereigns or financial institutions.

New thinking

The high-yield bond market is still dominated by deals to refinance bank debt as European banks look to de-risk their balance sheet. But Liberty Global’s £2.3bn ($1.14bn) buy-out of the UK media and telecommunications company Virgin Media “makes people think” about new leveraged buy-out situations, says Tanneguy de Carne, global head of high-yield capital markets at Société Générale Corporate and Investment Bank. There has even been a periphery buyout financed by a high-yield deal – a €EUR780m bond for CVC Capital’s purchase of Italian business information company Cerved.

By Mr de Carne’s calculations, European high-yield corporates issued the equivalent of €57bn in 2012, up from €48bn in 2011. The run rate in January 2013 was already €9.2bn, compared with €6.2bn a year earlier, and he forecasts about €65bn issuance for 2013. There is also appetite for moving down the credit curve, with about 60% of issuance year-to-date in the ‘B’ rating category and only 30% in the safer ‘BB’ bracket.

“If the US Federal Reserve changes course on interest rates and brings quantitative easing to an end, it will affect the market. But high-yield is a niche market, so it is less affected by the rotation out of investment grade fixed-income into equities,” says Mr de Carne.

If the positive sentiment toward high-yield bonds is maintained, he expects to see a growing number of smaller companies refinancing bank debt through inaugural bond issues. Recent examples include an issue for €180m by Italian air freshener manufacturer Zobele, and €250m (upsized from €235m) for French facilities management firm Atalian.