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Thursday, 14 December 2017

Shifting landscapes

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Primary market debt issuance has surged in Europe this year, and some banks have built out their resources to respond. But doubts still remain over whether the issuance bonanza is a long-term trend or a temporary reprieve from the doldrums of the past few years.

Amid accelerating demand among sub-investment-grade borrowers, issuance of bonds in euros is up 18% year-on-year, according to IFR data, reaching €878bn. Issuance in US dollars, meanwhile, has declined by 3% to US$2trn.

Behind the jump in European issuance is a mixture of technical and fundamental economic factors.

On the technical side, the five-year eurodollar asset swap rate has declined significantly from the 70bp–80bp highs seen in 2013 to as low as flat in April, before widening slightly to 13bp in the recent period, according to Citigroup pricing.

“We are witnessing increased investment flows into Europe, particularly from Asia and primarily China, and whereas historically many of those firms would have issued in dollars to buy assets in Europe that is no longer the case, matched funding is prudent risk management”

That means non-European companies are able to issue much more comfortably in euros and swap back to their domestic currencies, and in response Europe has seen a slew of firms from Asia, the Middle-East, Russia and Latin America tap the European markets in the recent period.

Perhaps more importantly, the fundamental landscape has shifted, with foreign direct investment flows recovering sharply in recent months, said bankers. The most recent European Commission statistics show EU-28 inward flows in 2013 were 12% above EU-27 flows in the previous year (Croatia became a member in July 2013).

Prudent risk management

“We are witnessing increased investment flows into Europe, particularly from Asia and primarily China, and whereas historically many of those firms would have issued in dollars to buy assets in Europe that is no longer the case, matched funding is prudent risk management,” said Hakan Wohlin, global head of debt origination at Deutsche Bank.

“We would observe that while there is no particular reason to diversify from dollars, the view the further east you go is that it may make sense not to have all of your eggs in one currency basket.”

Some 15 Asian corporates (ex-Japan) have issued euro-denominated bonds since the beginning of last year in deals worth €6.4bn, according to Dealogic. One example was Bharti Airtel, India’s largest mobile-phone carrier, which in May offered euro-denominated securities for the third time in six months.

The rise in appetite for euro-denominated funding has played out in bank revenues, with year to-date European bank DCM revenues reaching US$5.3bn, according to data provider Dealogic, compared with US$4.7bn for the same period in 2013 and US$4.2bn in the same period in 2012. US DCM bank revenues, by contrast, have declined, with banks posting US$6.3bn of revenues in the year to-date, compared with US$7.2bn in the same period in 2013.

“If you look at the growth of the market in Europe, it’s a structural shift, fuelled by deleveraging among European banks,” said Mathew Cestar, head of leveraged finance in EMEA at Credit Suisse. “In the past six years in Europe the high-yield market has grown four-fold, which represents a tremendous reshaping of the pool of capital.”

High-yield primary market volumes in Europe were €92.5bn in the year to-date, according to Credit Suisse, compared with €63.4bn in the same period in 2013, with the bank predicting annual issuance will hit a record €130bn in 2014, smashing 2013’s €87.4bn record.

Continental divide

The total European high-yield market is now around €292bn, compared with €58bn in 2008. That’s still small compared with the US$1.4trn US high-yield space, but while the US market has grown by about 50% since 2008 the European market has expanded by 500%, In addition, European high-yield has outperformed US high-yield in five of the past six years.

With companies in Europe at a different stage of the credit cycle to their US counterparts, the trend is set to continue in the coming years, said Cestar.

“The refinancing that needs to get done in the European market place is around €305bn in the next few years, which is a large chunk of business that commercial banks are unlikely to finance through private loans and which will be taken up by institutional investors who continue to be underweight in this geography.”

The most obvious indicator of the divergent paths of the US and European markets is risk free rates, with the 10-year Treasury note currently trading at around 2.5%, compared with around 1% on its German 10-year Bund counterpart.

“We see growth in the US and Europe increasingly coming from a material uplift in mergers and acquisitions,” said Cestar. “Additionally, in Europe, there is a larger refinancing need, which comes from the fact that the economic cycle is running slightly behind the US, which has already seen a lot of debt maturities extended.”

Among outstanding refinancing deals this year, cable operator Numericable and Dutch parent Altice attracted overwhelming demand for the largest high-yield bond offering to fund the acquisition of French mobile phone operator SFR from Vivendi.

Banks attracted some US$100bn of orders for the three-tranche dual currency US$16.7bn deal. In another example of Europe’s ability to cover significant deals, Italian telecoms firm Wind in April sold a €3.75bn-equivalent high-yield bond as part of a refinancing of senior and PIK notes.

Secular trends

Many of Europe’s banks have been building out platforms to reflect the increase in focus on Europe, and in some cases also on global non-dollar markets.

Credit Suisse has seen a number of senior players join the bank, including Allison Howe, among the most senior female leveraged finance bankers in the market place, who joined from UBS in August. Credit Suisse merged its leveraged finance and sponsors teams in 2013.

“If you look at European leveraged finance overall we have seen fees paid increase by 45% over the past five years,” said Cestar. “That’s a pretty good result given that we are in a recessionary environment.”

Deutsche Bank, meanwhile, is focused as much on emerging markets as it is on Europe, having maintained the platform it built up in the 1990s.

“The secular trend is for more companies to issue in local currencies, because that should, all things being equal, be cheaper,” said Wohlin.

“So if you are going to compete as a global debt house you need to do so on all these currencies. A change in one country, for example the Taiwanese ruling in May that allowed insurers to buy more foreign bonds, effects markets throughout the globe, and it helps to have a platform with ears and tentacles out there, as well as the right sales and training.”

Still, despite Europe’s recent strong run, it remains the case that the longer-term trend mitigates in favour of dollar markets.

The size of the eurozone bond market at the end of Q1 2014 was €20.3trn, based on ECB data. That’s 75% (€8.5trn) more than 10 years ago, with growth three times the rate of the economy.

However, whereas the US bond market has grown by 18% since 2010, the eurozone bond market has grown by 8% over the same period – a quarter of the rate of the previous four years. And it has actually shrunk slightly since the beginning of 2013, because of high levels of redemptions.

In other words, the exceptional growth trend is very short term, and the European markets credentials are still some way of being proved.

“Inevitably you need to have a balance. The US capital market remains the most profitable region of the world to transact business and the investor base is more mature, so to ignore the US would be folly,” said Anthony Barklam, international head of debt capital markets at the securities arm of MUFG.

“Having said that, Europe will be an important growth area, as will the Asian markets, over the next five to 10 years.”

To see the digital version of this report, please click here.

To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com.

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