Friday, 21 September 2018

IFR Top 250 2007: Quietly busy

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And so it continues. In spite of a few temporary setbacks, the credit markets have remained robust throughout the year, with cash-rich investors providing a solid foundation on which to build. Although issuers have been willing to indulge this demand, supply is eagerly snapped up as buyers look to put their money to work. Philip Wright reports.

Call it being blase; call it being used to high volumes of business, but market observers have been saying for much of the year that it feels quiet. The truth is that it is not. Overall supply is not in the least out of step with the recent past, and the amount issued actually represents an incremental increase over the last couple of years.

According to Thomson Financial data, the amount of international bond paper issued across all unsecured asset classes in the first five months of 2007 was US$1.907trn equivalent, up from US$1.546trn in the corresponding period in 2006 and US$1.253trn in 2005.

“Volume is stable, but sometimes it just feels like there is a dearth of supply,” said Amir Hoveyda, head of global financial institutions origination at Merrill Lynch and until recently head of EMEA DCM. “There is massive and ongoing liquidity that is outpacing supply and this continuing imbalance is reflected in secondary spreads.”

While it is inevitable that the market will turn at some stage – there have already been a couple of hiccups along the way – given the market's resilience, no-one seems to feel sufficiently confident to prophesy when this might happen, or what the catalyst will be. In the meantime, whatever their private thoughts might be, bankers are carrying on and accommodating the demands of both buyside and sellside.

“Who knows what triggers it and when it happens, but for now, we are not going to be more royalist than the king,” said Hoveyda.

"Credit market participants are of course focused on trying to predict the dramatic event or tipping point which could cause a significant repricing. But they are equally interested in observing and understanding the characteristics of a market during the longest bull run on record," said James Garvey, head of investment-grade DCM at Goldman Sachs.

That view is echoed by Jean-Francois Mazaud, global head of origination at SG CIB, who is fully cognisant of the difficulties associated with trying to predict the end of a bull market run that just seems to shrug off all events that might reasonably herald a weakening.

“Last year, we had anticipated a possible change in market appetite for primary issues on a 12-month horizon, and it did not happen,” said Mazaud. “We are in the middle of 2007, and even if the environment is a bit more volatile we don't foresee yet any structural reason for a substantial change of behaviour from investors or issuers.”

One thing is for sure, Mazaud will not have been alone in underestimating the market’s durability.

"Logically, the downturn will happen, but when? Will it be within the next six months? Probably not with the supporting factors still present in the market such as the high level of redemptions, the overall liquidity, the contained growth of new issue volumes or the absolute level of credit spreads mitigating the rise of interest rates," he said.

The situation is being driven by a virtuous circle that sees a coincidence of ambitions from both the buy and sell sides. While investors remain cash rich and are willing to entertain virtually any proposition presented to them in just about any size, issuers are finding that the consequent tightening in credit spreads has largely mitigated any rises in rates, while the backdrop remains benign as far as accessing the market at desirable levels is concerned.

The bulk of new issues continue to attract high levels of oversubscription and just about the only thing that could dissuade issuers from acting now is the prospect of even more advantageous conditions to come.

“Levels are pretty much as good as they’ve ever been, and our advice to issuers is that they should consider pre-funding. You might leave a few basis points on the table, but in the grand scheme of things and from a historical perspective there is more downside risk in waiting,” said Merrill’s Hoveyda.

Although there is little dissent when it comes to the favourable phase through which the market is passing, not all potential underwriters are recommending exactly the same strategy.

“We think issuers should be super opportunistic, but there is no need to hurry,” says SG’s Mazaud. “If you can wait six months, chances are things will be even better. The future is less uncertain than it was in the past and it is not advisable to up your cost of carry [by pre-funding] if you have no need. Why lock in spreads when they could improve?”

In Europe, it is the more opportunistic issuers of flow supply that have been noticeably more active than last year. On the other hand, the more strategic sectors have been progressing at a pace more in line with 2006, suggesting that issuers are indeed gravitating towards this opinion.

Supply in euro-denominated senior unsecured bonds from financial institutions, for example, had reached €235bn by the end of May compared with €188bn at the same stage in 2006. That led to a full-year figure of €366bn, a level that looks likely to be surpassed by the end of 2007.

January alone saw almost €90bn of issuance compared with less than €50bn in the same month in 2006, and the only month that failed to trump the previous year’s tally was March – and that was a close-run thing – when the first fears concerning Chinese equity market were voiced and the iTraxx Crossover index gapped out to 235bp, having just broken through 200bp on the way down. By the end of May it had tightened in to the 190bp area and the trend of generally increasing volumes (2005’s full-year figure was €296bn, just below 2004’s €310bn but substantially above 2003’s €238bn) seems set to continue.

Corporate volumes

The corporate world is also showing signs of breaking through last year’s volumes with €63bn already issued by the end of May, just over half of 2006’s €125bn. And it has not done so in any piecemeal fashion, as the average transaction size is close on €500m, a level not threatened since 2011 when the mammoth telco financings were in full swing.

In addition to growing sizes – “I remember when €2bn used to be a lot of money,” said one London-based FIG syndicate official – the two sectors have also shared a trend towards multi-tranche, multi-currency transactions that are invariably launched and priced in double-quick time, pricing at the tight end of spread guidance in addition to being at the upper end of or even beyond initial size aspirations.

Although more vulnerable to wider market hiccups than financials, corporates too have proved resilient, overcoming hurdles as and when they have been placed in its way. There has been much in the way of shorter-end floating-rate supply, however, and not so much at the long end, with issuers unwilling to pay the premium demanded, many being of the view that more opportune moments will arrive. Not only does this display a confidence in the future but it also shows issuers using FRNs as a "bridge to bonds", as SGCIB's Mazaud puts it.

What has again been noticeable by its absence is any meaningful supply in corporate hybrids. While some estimates at the beginning of the year were talking of €10bn in supply, so far the reality has been less than €1bn. With M&A the driving force behind this market (60% of hybrids are for this purpose as opposed to 22% of vanilla bonds) any interruptions in this arena – whether a proposed acquisition that did not take place or simply a change in manner or order in which a purchase is financed – will have an effect on the overall numbers. That said, with an average deal size around €1bn, it would not take too many issuers coming to the market to get those predictions that currently look overly optimistic right back on track.

One area that has spread its wings, globally, is covered bonds. In Europe's Mediterranean zone, Portugal and Italy have joined the international covered community, while in Northern Europe Norway and Denmark have followed Sweden’s lead to complete a Scandinavian hat-trick. Add to this ongoing discussions in the Netherlands and changes likely in Ireland, Spain and the UK and it is clear it is not a market that likes to stand still.

Although the supply of jumbo issues from the sector slightly undershot 2006’s €78.6bn in the first five months, the emergence of new names from such markets should see the full-year figure of €179bn at least challenged.

But it is perhaps the advent of a nascent US market for bonds issued by domestic issuers that has been the most keenly awaited. With Bank of America getting the ball rolling, others are sure to follow, although in terms of adding to the overall supply figures, many hopes for covered bonds in the US being pinned on their acting as surrogate agency paper, where new inventory is increasingly difficult to find.

With European sovereign issuance also failing to match demand, much of the challenge for borrowers is to persuade account managers to accept them as a high-grade investment alternative with pricing to match.

Asia goes private

And the story is similar in Asia, with economic growth continuing apace, driven by China and India, and the financial crisis of 10 years ago seeming a minor bump on the path of the region’s relentless ascent.

Asia’s sovereigns were abundant providers of G3 bond supply in the past, but thanks to the build-up of central bank reserves – in part to cushion the region’s economies from a repeat crisis – combined with healthy fiscal balance sheets, sovereign issuance from the region has declined.

The relative lack of supply has caused widespread frustration, with the region’s real-money accounts awash with liquidity and shouting for Asia’s sovereigns to adopt the innovative approach to structure and tenor seen in Europe – but to no avail.

New sovereign names such as Vietnam have provided what little excitement there has been in the sovereign space, and have met with overwhelming demand, with credits lower down the curve such as Bangladesh, Cambodia and Sri Lanka waiting to follow Vietnam’s lead. These names can hopefully inject some life into a market sector that has become frustratingly commoditised, with past frequent issuers such as KDB and Kexim motivated purely by price and little from the Asian sovereign and quasi-sovereign space offering anything more than a sliver of alpha.

High-yield has been surprisingly slow in Asia, with just five public deals printing, and the China real estate and Indonesian resources sector dominating again as they did last year. But this is deceptive. The private space has been reprising its rip-roaring performance of last year and volume estimated to be in the US$18bn area versus just over US$2bn in the public arena.

“The Asia private market is on fire, with real-money reverse enquiry driving the issuance and no end to this flow in sight. Borrowers are keen on the light covenants and low disclosure versus public deals and investors are ravenous for the 10%-odd coupons,” said a regional DCM banker.

Buy-backs in vogue

In the US, while not a new phenomenon, the financing pendulum continues its swing towards equity performance with companies unveiling massive stock repurchase programmes as the spectres of private equity and activist shareholders loom.

After a couple years of repair, balance sheets are in good shape and underwriters are using that rationale in pitches to corporate clients.

"If you can tap the debt markets to buy back stock without jeopardising your ratings, I can't see many reasons why you wouldn't," said one DCM head.

Repurchasing stock is not the gradual exercise it once was. With accelerated stock repurchase programmes, the process of receiving the stock is hastened, to a near immediate benefit of earnings per share figures through bridge loans that are then termed out in the bond markets. National Semiconductor and Valero Energy are two recent examples of infrequent issuers that emerged in the market with benchmark transactions slated to refinance buyback-related bridge loans.

The surging amount of equity buybacks has contributed to the recent records set in the broader market indices. The allure of increased returns has the potential to pull significant amounts away from risk-free and highly-rated instruments, and into alternatives. China, one of the largest purchasers of Treasuries over the past couple years, recently used its Lian Hui investment vehicle to acquire a stake in Blackstone Group.

Likewise, liquidity in the riskier debt markets remains strong, even as the market for unsecured securities is occasionally troubled by brief stints of spread volatility. Product offerings are also broadening, with the advent of a viable US dollar-denominated covered bond market and a surge in tax-deductible hybrid offerings.

Spread corrections have left some investors increasingly concerned. Such movements are yet to provide a definitive sign that investors should shy away from the market as global economic growth is set to compensate for any prolonged weakness in the US. And if investors make their future decisions based on valuations alone, they risk losing out on a market that has strung together multiple years of steady gains.

The global theme then is one of cash-rich investors chasing yield that it is not always easy to locate. That is not to say that bond market participants are willing to buy anything at any price, however. While covenant-lite structures are becoming increasingly prevalent in the loan market, where similar supply/demand dynamics apply, fund managers on the bond side are well aware of the power they can wield. Change of control language is fast becoming a pre-requisite, certainly as far as corporate issuance is concerned, and there are also signs that investors would be keen to push for it more in the financials sector if they thought that they would be successful. Rumour has it that some issuers now feel more comfortable holding one-on-one meetings rather than group presentations, where investors are more likely to exert their combined influence.

For the time being, however, the delicate balance between supply and demand appears to be producing an environment that benefits issuer and investor alike. That is until one of the market's periodic bouts of hiccups turns into something more serious, though when that is likely to happen and what will trigger it seem to be as elusive as ever.

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