The age of maturity
The escalation of the sovereign debt crisis has led some of Europe’s political leaders to talk of an age of austerity. But for the continent’s corporate treasurers, there is a different concern: as time elapses their debt profiles are steadily maturing. For a solution, many are turning to liability management. David Rothnie reports.
Between now and 2013, approximately €556bn of corporate debt will mature, according to Thomson Reuters. Of that, roughly half relates to bonds that will mature by the end of 2011 and have been extended, leaving a pipeline of more than €250bn requiring refinancing. The biggest spike is in 2013, when €172.3bn of outstanding bonds will mature. That is focusing the minds of corporate treasurers and debt capital markets bankers alike. Welcome to the age of maturity.
Despite the recent sovereign crisis that has hit spreads, the cost of funding remains attractive for the right company, according to bankers. “The all-in-cost of funding is only a factor driving liability management exercises,” said John Cavanagh, managing director and head of liability management for EMEA at Bank of America Merrill Lynch. “Other arguably more important factors include market access, companies seeking to extend their redemptions and diversifying their funding, and companies taking a more prudent approach to balance sheet management.”
The trigger for this prudence was the seizure of markets following the collapse of Lehman Brothers in September 2008. Until then, treasurers had started to take refinancing for granted, assuming that tight spreads and low interest rates would continue indefinitely. The closure of markets was a wake-up call. Interest rates remain at historic lows and corporate bond spreads have snapped back, making for low funding levels. Yet with volatility high and markets ebbing and flowing to the sovereign crisis on a daily basis, treasurers can no longer afford to be complacent.
“When markets closed following the collapse of Lehman Brothers in 2008, it reminded treasurers that there certain are windows of opportunity for funding which can close at any time,” said Mark Lewellen, head of European corporate origination at Barclays Capital. “This is focusing minds on liability management and extension of debt maturities.”
Companies want to reduce maturity spikes and push out debt, whether through buybacks or exchanges. Ratings agencies are also taking a longer term view. There has been a redefinition of what is a benchmark size for bond issuance. Previously, companies would regularly tap markets for €3bn in a single tranche, but now it is more usual to issue in smaller chunks, of say €500m, as companies look to diversify the duration of their debt.
“After the crisis, when the market was closed to everyone, issuers took the view that they did not want huge financing risk so sought to slice the top off their four biggest exposures,” said Stephanie Sfakianos, head of debt restructuring at BNP Paribas. “People want to tackle their exposure spikes earlier.”
With companies taking a pro-active approach to managing their debt profiles, and an uncertain outlook for interest rates, liability management exercises are on the rise. Last year was a bumper year for liability management exercises: the world’s biggest financial institutions undertook a massive restructuring of their debt, as government-backed programmes enabled them to buy back debt and exchanging at below par. According to estimates from Bank of America Merrill Lynch, there were €85bn worth of transactions relating to liability management exercises conducted last year, almost double the previous high of €46bn in 2006.
With financial institutions taking a pause from the market, it is now corporates’ turn to wrestle with their capital structures and extend the maturities of their debt at relatively little cost. In doing these liability management exercises they are encroaching on territory that has traditionally been the preserve of financial institutions.
In the first five months of the year, BofA Merrill estimates deals with a value of €35bn were executed. The data does not distinguish between FIG and non-FIG borrowers, but the trend is clear: the wave of FIG deals that saw banks buying back debt and exchanging at below par is over and has been replaced by a resurgence of corporate liability management. “We expect that to continue for at least the next 12 months,” said Cavanagh.
A liability management exercise involving a tender and new issue enables a company to work with existing investors that are already knowledgeable about the credit, enabling a more efficient execution. It also addresses potential concerns from rating agencies and investors. On the other side of the trade, investors enjoy receive a premium to secondary market trading levels as compensation for the duration extension.
A liability-driven fork in the road
Treasurers face a dilemma in deciding whether to pursue a buyback and new issue, or launch an exchange offer. Both have their advantages and disadvantages.
In times of depressed bond prices, companies bought back their bonds outright and booked accounting gains on the discount – the difference between what they paid and the original value they were issued at. However, where a company’s bonds are trading above par the company bear’s the difference as a cost. If new bonds are issued in exchange IFRS accounting standards makes them eligible for “exchange accounting treatment”, which allows the buy-back premium to be amortised.
“Under exchange offers, companies gain a more efficient cost of funding and investors get newer, longer-dated bonds,” said Cavanagh. “An exchange would be preferable to a new deal that exceeds demand and where issuers have to offer more attractive for investors. Instead two smaller sized deals with greater demand can afford a tighter spread to cover the book size, lowering the all-in cost. This gives treasurers a back-up plan.”
“Where the new issue market is a challenge then the beauty of an exchange for the issuer is that in the worse-case scenario investors keep the old bond,” added Sfakianos. “In the best case scenario they take a new bond with a longer maturity. In this case, it is a cautious trade.”
The disadvantage of the exchange offer is that they bring with them price uncertainty: the price is not fixed for four or five days after it is issued, which may be undesirable in times of volatility. Furthermore, existing investors may not want to exchange, or they may no longer be the right kind of investors. Where an issuer is seeking to exchange a two-year outstanding issue with a new ten –year bond, for example, investors in short duration bond funds will not be able to participate.
“Investors have a lot of cash put to work and they are concerned about re-investment risk,” said Sfakianos. “Investors may see no value in selling out of a bond then struggling to re-invest in a new issue which may be oversubscribed and in which they may struggle to get their allocation.”
There is no hard-and-fast rule and the best option varies from company to company. This month, French chemical company Air Liquide braved the recent market volatility and effectively re-opened the market with a €331m exchange/tender offer, intended to convert €500m of 2012 notes into new 10-year note. The trade combined an exchange offer with a cash alternative, which, because it was issued by BNP Paribas acting as an intermediary, was exempt from the one-off accounting charge. Air Liquide, rated A, was a rare and quality name and coupon spreads had widened. The coupon for the ten-year exchange offer was 3.888%, which was very attractive.
By contrast, earlier in the year Rallye opted for a new issue and a buy-back with a €116m tender offer targeting 2011 notes and new issue of 2014 notes. This carried big execution risk: there was a danger associated with issuing the new bond before the buyback, but Rallye timed both trades to settle on the same day. The company was unrated and its priority was to get the deal done. A new issue was therefore regarded as the less risky option.
The Air Liquide deal is part of the new wave of deals that extend maturities on 2012 debt. Bankers predict a healthy pipeline of similar deals. Issuance has traditionally been constrained by blackout periods and seasonality. However, the new proactive approach from treasurers means that European companies are starting to adopt a year-round mentality to funding, rather than deferring any refinancing decisions over the summer, according to bankers.
“A resumption in the M&A calendar will see issues relating to buying up outstanding bonds of the target company,” added Cavanagh.
However, bankers predict that it is only a matter of time before FIG borrowers return to the market. A trigger point could be the new regulatory regime ushered in by Basel II recommendations, which will set new rules for the amount of capital banks must set aside. “Once Basel II is set, financial institutions will undertake widespread liability management exercises in order to arrive at the optimal capital structure,” said Sfakionos.