Tuesday, 18 December 2018

Bond and a hard place

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  • Bond and a hard place

Investment-grade corporate issuance has rarely been in such demand, especially when it is so plentiful. Syndicate desks now face the challenging task of balancing the needs of investors and issuers when bulging books of demand see corporates pushing to achieve record terms.

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If I die, President Bill Clinton’s chief strategist James Carville once said, “I want to come back as the bond market. You can intimidate everyone.”

Carville’s words, spoken in the early 1990s, still ring true today. Market volatility – the killer of long-term value – has seen investors in recent years flee equities and once rock-steady sovereign debt, eschewing both in favour of investment-grade corporate debt.

But soaring demand for investment-grade bonds has created its own quandary, particularly for syndicate desks seeking to strike a reasonable (and profitable) balance between the competing needs of issuers and investors.

All summer long issuers have pressed malleable syndicates to price their debt super-aggressively. Investors, lacking viable alternatives, have largely acquiesced. But how aggressive can deals be before investors shun deals? And has massive oversubscription for the best corporates changed, briefly or fundamentally, the way syndicates price bonds?

There is no doubt that, in these days of supreme uncertainty, power lies in the hands of the best investment-grade issuers. Richard Tynan, head of sterling syndicate at RBS, describes corporate debt as the current “asset class of choice”, noting “demand for investment-grade corporate debt feels like it’s at an all-time high, and isn’t going away”.

Investors looking for deals that offer a shelter from the storm, adds Brendon Moran, global co-head of corporate origination at Societe Generale, look around Europe, at the headline risks bouncing around since the end of 2011, and alight on corporate bonds, the “one asset class with resilience, less volatility and higher returns”.

Ravenous investors

That’s good news for higher-grade issuers; less so for syndicates seeking to manage both overwhelming demand for new paper, while leaving enough on the table for ravenous investors. Some deals, indeed, are priced so tightly, it is easy to imagine investors walking away.

“Investors looking for deals offer a shelter from the storm, look around Europe, and alight on corporate bonds, the ’one asset class with resilience, less volatility and higher returns’”

Others, meanwhile, are embracing the challenge. Moran said that oversubscriptions often “force syndicate managers to find a balance that doesn’t upset the one or other side of the market. You get investors complaining about the way executions are handled. Of course, that’s a quality problem to have”.

A few recent deals have tested both this theory and investors’ resolve. On September 3, Swiss food firm Nestle launched an €850m benchmark bond which, at just 1.75%, marked the lowest coupon ever issued in the history of the euro. That followed hard on the heels of another eye-popping Nestle deal: a seven-year July 2019 bond, issued with a coupon of 1.5%, which attracted more than €6bn in orders. Bank of America Merrill Lynch, BNP Paribas, HSBC and RBS were lead managers on the sale.

Consumer goods firm Procter & Gamble also launched its own blockbuster in August: €1bn worth of 10-year bonds priced at 25bp above mid-swaps, even tighter than its last euro-currency issue, priced at 50bp over mid-swaps in October 2007.

A headache of quality

Again, this creates its own set of vexing issues for syndicates, who can choose to see the challenge as a headache or, using Moran’s words, a “quality problem”. One leading syndicate manager in London describes the job of selling investment-grade debt as a “thankless task” at the moment.

“Issuers want the tightest spreads possible, and investors want the widest spreads possible, and this is a hard balance to find. If you go out with a deal that’s wrongly priced, it may struggle [and bring the market to a halt],” said Moran.

So far, at least, that hasn’t happened – even when the likes of P&G and Nestle appear to leave so little on the table. Syndicate managers, as with all in-demand products, whether corporate bonds or iPhones, follow the herd, however rational their logic may be.

Most of the big corporate bond deals done during the summer were, said Marco Baldini, head of corporate fixed income syndicate, Europe, at Barclays Capital, momentum trades destined for completion, whatever the price. “Once you’re on the book, everyone wants to be on the book,” he said. “If you don’t want to be on the book and you say it’s because prices have tightened and you drop out, you look stupid when the deal tightens further.”

Aggressive pricing does appear to have done little so far to repel investors. Indeed, demand for investment-grade corporate debt is rising, sucking both new and regular issuers back into the market.

US corporates issued more euro-denominated corporate debt in August 2012 (US$1.8bn worth) than in any single month since the onset of the European sovereign debt crisis in late 2009. The first fortnight in September saw more investment-grade corporate debt issued in Europe – US$78bn – than was issued in any two consecutive weeks since March 2012, according to Thomson Reuters.

The question of whether too aggressive pricing on one issuance, or on a series of deals, may sink the market, as it has done in the past, has also turned out to be moot. No major investment-grade deal has come close to pricing itself out of the reach of investors. RBS’s Tynan said: “With the right corporate name and in a poorly supplied market, you can be significantly through fair value and still see a book that is four to five times oversubscribed.”

Anthrax appeal

And it isn’t just the likes of P&G and Nestle leading the charge. Corporates from peripheral European countries like Italy and Spain, once viewed by the market as being only slightly less attractive than anthrax spores, are back in business.

On September 5, Spanish telecoms firm Telefonica issued €750m worth of five-year bonds: in its first deal since February. Five days later, Spanish utility Iberdrola priced a six times oversubscribed €750m five-year deal, priced at 360bp over swaps, its first market foray in six months.

Other peripheral Europe deals were cut by Telecom Italia (a €1bn five-year bond 20bp inside initial guidance and 5.5 times subscribed), along with debt sales by Spanish banking trio Banesto, BBVA and Santander.

The recent revival of peripheral Europe is interesting. This resurgence is, for the moment, less the second coming than a mere renewal of interest in the small handful of investment-grade corporates scattered around the continent’s tattered outer edges.

“The market will need more time before they start moving into second-tier [peripheral European corporate debt] deals,” said Frazer Ross, head of the new issue bond syndicate at Deutsche Bank.

Yet it does point to better times ahead for Europe’s leaky fringes. Combined debt issued by corporates from the PIIGS area countries totalled US$23.1bn in the four weeks to September 14, up from just US$3.6bn in the previous four weeks.

Finding their mojo

And the revival, however brief it may turn out to be, does raise interesting points about the state of the market. First, the late summer arrival of good tidings has calmed markets. European Central Bank President Mario Draghi’s pledge to “do whatever it takes” to preserve and backstop the single currency opened up parts of the market (including peripheral Europe) that most investors had recently feared to tread. More good news came from such diverse elements as the Federal Reserve, the European constitutional court, and the Dutch elections.

Second, confidence was self-reinforcing. Draghi’s comments, said Baldini, helped investors regain their mojo. “They feel confident in that they are backstopped by central banks. There is this assumption that if things get bad, the central banks will step in and bail them out, so investors are feeling pretty gung-ho right now.”

Third, perhaps as a result of Draghi’s proclamation, turbulence has not been the negative factor many feared. “Most of us were thinking that September would be very volatile,” said Morven Jones, head of corporate and sovereign, supranational and agency debt capital markets, EMEA, at Nomura. Volatility has even gone down: Jones says it was waning before Draghi’s magic words. Others believe confidence has returned merely because investors have got a whole lot better at handling uncertainty.

More than a flash in the pan

And there may be a final point of order here. As supply washes back into the market, investors are being offered a genuine choice for the first time in months. Debt issued by, say, peripheral corporates is riskier – and therefore priced more generously. As demand for, and greater supply of, higher-yield debt permeates the market it may, believes one syndicate manager, widen coupons even on investment-grade deals.

Many are now hoping September wasn’t a mere flash in the pan. Will the markets continue to improve, damping volatility and bringing more issuers out of the closet? Market participants feel broadly confident about the future for the first time in years. Baldini believes that current confidence-led activity “is going to last”; RBS’s Tynan tempers his “cautious optimism” with the warning that “every rally has an end”.

Deutsche Bank’s Ross said much would depend on the actions of central bank governors, though he also believes the good times are here to stay. “The markets are coming to terms with the fact that: a) there is no simple single panacea, and b) politicians are working together more effectively than they did at the early part of the crisis, to deal with problems.”

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