The market for medium-term notes (MTNs) is often seen as a bellwether for the rest of the bond market. When MTN bankers start seeing signs of stress, it often does not take long for cracks to appear in the public bond markets.
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Debt bankers were thus relieved with the robust start to the year made by the MTN market. This came in spite of the high supply of public bonds, including several benchmark-sized ones. Often in a fragile and recovering market, investors tend to focus on high-profile, public deals and only switch to MTNs, which are usually driven by reverse enquiries, when they are more confident about the market’s medium-term health. “Sometimes there’s a lack of focus from investors on MTNs when there is a lot public issuance,” says Olly Johnson, head of MTNs at Bank of America-Merrill Lynch. “But despite a busy public market, flows of MTNs have been good so far this year.”
Investors have been busy trying to find opportunities to buy private placements, which marks a change from the second half of 2011, say bankers. They add that bond buyers, while still sensitive to developments in the eurozone, including Greece’s attempts to obtain a second bailout tranche, have felt it futile to sit on the sidelines until they perceive the crisis to be fully resolved.
“Investors realise that a silver bullet solution to the eurozone crisis simply doesn’t exist in the short term and that we’re in an environment where uncertainty and austerity will be with us for years if not decades,” says Chris Jones, who was global head of MTNs at HSBC until mid-February. “But they’re sitting on substantial cash piles and they have to put them to work somehow.”
Easy for SSAs
Demand for MTNs has particularly centred on sovereigns, supranationals and agencies (SSAs) and non-financial corporate borrowers. The strongest of these have enjoyed fairly easy access to the market. And they have also been able to issue long tenors.
Yet SSAs from peripheral eurozone countries have also been able to tap the market. Fade, Spain’s electricity deficit amortisation fund, printed an MTN of 15 years, its longest ever tenor, in early February. Another deal that bankers said exemplified growing risk appetite among investors was a €230m 30-year MTN from Italy in late January.
Bankers say Italy’s bond showed that European sovereigns realised it was essential to diversify their funding and not try to sell public deals only. As such, most are following up any reverse enquiries they receive from private placement investors. “Sovereign issuers are fully aware that a decent chunk of their funding this year will have to be done in the MTN market,” says Mr Johnson. “So they’re all reacting pretty quickly to opportunities.”
Pricing has widened in the past six months even for the strongest SSAs. Some, such as the European Investment Bank, which could issue bonds with yields close to the level of mid-swaps until recently, now have to pay a significant premium to that benchmark.
But bankers say the rise in funding costs has not been high enough to cause major worries. They add that some borrowers have attracted new groups of investors because of the wider spreads they are offering. Agency issuers from France, whose yields have increased in tandem with those on French sovereign bonds in the past six months, have proved eye-catching to some German investors, who cannot always get the returns they want in their home market. “The magic number for German insurance companies is currently 4%,” says Amaury Gossé, a director in Citi’s MTNs team. “They struggle to get those yields at home, given how tight bunds are trading. As such, they’ve been quite heavy buyers of French agency paper and covered bonds since the start of the year.”
Corporates look good
Corporate borrowers have also been in high demand. Investors have been keen to buy their paper, thanks to the high quality of their risk profiles and balance sheets. They used to be perceived as collectively riskier than SSA and financial institution issuers before the 2007 crisis. Now many, especially those rated 'A' or higher, have far lower funding costs than their local banks. Some in Spain and Italy can even issue bonds tighter than their respective governments can.
MTNs for fairly frequent borrowers such as German carmakers Daimler, Volkswagen and BMW, and GE Capital, an arm of General Electric, are usually snapped up whenever they are sold.
There has been some supply this year from companies that rarely come to the private market. Among those to issue have been Repsol, a Spanish oil firm, Assa Abloy, a Swedish maker of locks and other security products, and Metro, a German supermarket chain.
The problem for investors is that there are still too few corporate MTN issuers. Most companies do not have big enough funding programmes to warrant much MTN issuance, which often requires borrowers printing in niche currencies and with unusual structures to match the demands of reverse enquiries. They usually prefer just to issue just one or two benchmarks in the public market each year.
Moreover, given their strong cashflows and fairly low debt levels, corporate borrowers are not under much pressure to diversify their funding from public markets.
Not all borrowers have it easy, however. Many financial institutions group, or FIG, issuers are finding it particularly difficult to access the market. Demand for their unsecured MTNs is especially shallow, particularly for borrowers from Europe’s periphery. “If an investor is going to buy senior unsecured bank paper, they are going to be very selective of the borrower’s geographical origin,” says Mr Johnson. “Most European investors we speak to are still cautious about Italian, Spanish and Portuguese names.”
Covered bonds away
The bulk of FIG issuance this year has thus been in the form of covered bonds. “Given the option, issuers would jump at the chance to print senior unsecured paper over covered bonds,” says Mr Johnson. “But MTNs are driven by investor demand and reverse enquiries. So, if there’s demand for covered bonds, that’s what we’ll see get done.”
A €1.5bn public deal from Italy’s Intesa Sanpaolo in early February, the first senior unsecured bond from a peripheral European FIG borrower this year, suggested that investors were beginning to consider structures other than covered bonds from banks. But most analysts still think the bulk of FIG issuance in the MTN market in the foreseeable future will be in secured format.
This poses difficulties for borrowers, given that covered bonds are a costly way of using their best assets, of which they have a limited amount that they can use in their cover pools anyway. “The heavy supply of secured issuance can’t go on ad infinitum,” says Mr Jones. “Everyone has got ratios they need to maintain. Nobody can do their whole programme in secured format. There’s only a finite pool of assets they can use as collateral for covered bonds.”
Banks facing funding problems would have likely tapped the European Central Bank’s (ECB's) longer-term refinancing operation (LTRO) at the end of February to obtain cheap three-year debt. But Citi’s Mr Gossé says that banks would like to issue unsecured bonds even if they are more expensive than ECB lines. “Markets are all about impression and perception,” he says. “If a bank today issues an unsecured bond, it’s because it can, not because it has to – it could just tap the ECB’s LTRO instead. So by doing an unsecured deal, banks can make a very positive impression with investors.”
Whether investors will soon change their attitude towards bank paper depends largely on developments in the eurozone. They will be watching Greece closely in the coming weeks. Should it fail to avoid a disorderly default and contagion spreads to Italy and Spain once again, FIG issuers’ attempts to sell unsecured MTNs are likely to remain futile for a while yet.
