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Thursday, 23 November 2017

Top 250 2005 - A price for everything

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So while it appears that concessions are available across the board from prefs, through fixed-rate, to CMS, the results are not as onerous as the alternative, which is to say not being able to raise the capital. All sectors remain open: it is just a matter of price. By Philip Wright.

March’s hiccup in the credit bull run caused the primary market to pause for thought as issuers and investors sought to acclimatise to the new conditions. But a need for investors to put money to work in the bond markets has meant that supply has built up again and the whole gamut of structures is now in play. Nobody was found clutching the knife when the lights went on after mid-March's correction in spreads. There was no murder victim in the end; just a few market pundits whose egos suffered a couple of puncture wounds.

This is not to downplay the severity of the downturn, however, just to underline the fact that it was not terminal – no matter how severe it appeared at the time. The market sprang back to life after a few weeks, and what has transpired since then is that there is appetite for all types of asset structure.

Of all the debt classes, the Tier 1 sector is the most inventive. Borrowers and bookrunners alike invest a vast amount of time and energy developing and nurturing the models they see as offering the best opportunities for all those parties whose requirements need to be met. Fashion, as is its wont, swings from one structure to another and often goes full circle.

When circumstances are benign and buyers are keen to put money on what at the time looks like a one-way bet, this can be little more than a question of rhetoric. Recent months have seen more need for invention, although the major conclusion drawn has been that all options remain open.

While that may be true, the spreads now demanded are rather wider than they were at the beginning of March, but then they were indeed halcyon days for issuers.

“I don’t remember a more constructive market in either institutional or retail,” commented Ronan Donohue, head of hybrid capital at Dresdner Kleinwort Wasserstein. “When things get to that point, they tend to react more quickly, however,” he added, talking of March’s correction and the subsequent need for realistic pricing as stabilisation took place at wider levels.

What has been notable has been that seemingly unstable conditions have produced issuance across a number of formats, including some that became singularly unpopular even while the bull market was running at full speed.

Chief amongst these is the CMS-linked market. Having been the market of choice throughout much of 2004 and after a brief but intense flirtation with curve-steepener language at the beginning of 2005, all went quiet.

“The reasoning behind the market was still valid. The trouble was that we had people getting involved with no natural reason for doing so,” said Anthony Fane, joint head of European financial institutions at BNP Paribas.

Every good idea eventually gets abused and CMS was no exception. Issuers looking for non-step up capital outside the 15% bucket saw the retail arena as the most cost-effective place to raise it, since there was really little alternative prior to Barclays' assault on the institutional market at the end of 2004 with its non-step issue.

A combination of oversupply and deteriorating sentiment had served to stagnate the sector, although it was ironically the mid-March hiccup and subsequent paucity of issuance that allowed the backlog of paper to be digested and ultimately cleared the way for a modest resurrection of the CMS product, according to Giles Hutson, joint head of syndicate at Morgan Stanley, which had a hand in all three of the issues launched this time round.

Deutsche Postbank started things off with its third visit to the sector – a €300m non-call six – and the following week saw DePfa replicate both size and maturity and Islandsbanki sell €150m of perpetual non-call 10 paper.

The new breed of bonds does differ in a number of important elements from the first generation, however. Most of the early deals featured one-year fixed coupons that are now coming to the end of their lives. With many of those issues trading in the mid 90s, it was clear that something more had to be offered.

The second generation of straight CMS-linkers towards the end of Q1 had already begun to feature two-year fixed portions before they completely disappeared from the radar screen. The latest version has similarly enhanced characteristics: DePfa and Postbank's issues, for example, paid a 7% coupon for the first three years, while Islandsbanki's paid 8% for five. The concessions also stretched into the floating-rate, back end part of the equation with DePfa paying CMS10 plus 10bp, Postbank pays 12.5bp and Islandsbanki switching to plus 20bp: 2004 saw spreads well into low single-digits.

The truth remains, however, that CMS best serves those looking for relatively modest volumes. Pushing through €500m marked the beginning of the end last time round, although it has been notable on the three recent deals that the size was capped by issuer requirements rather than investor demand. All three built books that would have supported greater transactions had the borrowers so wished.

Not so great as to satisfy the demands of those looking to launch large amounts in one exercise, however: for that, other means have to be found. While Barclays rediscovered appetite for non step-up structures from institutional investors, it has been the retail sector that has proved itself the most reliable provider of capital outside the 15% regulatory limit.

RBS gets its fix

RBS showed there was indeed an alternative to CMS back in November 2004, when it sold €1.25bn of perpetual non-call fixed-rate five paper. At the time, the CMS-linked market was experiencing one of its periodic bouts of indigestion, and it eschewed the format in favour of a tried and tested structure that had proved itself able to produce size when needed on previous occasions. While a CMS-linked issue may have been tempting in pricing terms, the volumes required would just not have been sustainable.

It renewed its acquaintance with the fixed-rate sector just recently, and although outwardly not much had changed, the reality that lurked beneath the surface was that risk premiums were higher than had been the case at the end of last year. This was true across all structures – the pay-off being that borrowers are presented with the choice of a number of different markets.

"All the markets remain open, although this comes at a price," said David Soanes, head of European investment-grade origination at UBS. He held up RBS's experience as a quintessential example, its recent 5.25% coupon being marginally better than the 5.50% achieved in December, the five-year call the same.

What was notably altered, however, were the underlying markets. From having stood at 4.50% in November, the 30-year swap had come in to 3.80%, while 10-year Bunds were in at 3.16% form 3.77% – 60bp and 70bp tightenings against a coupon just 1/4 lower.

"The risk premium has gone up as a result of the savage rally in government paper," continued Soanes. "It has dragged economics to a new level."

While Landesbanks HSH and WestLB have displayed that retail appetite for a fixed coupon also stretches as far as Asia US dollars in, it has been left to Barclays – almost single-handedly – to re-invigorate the institutional sector as a means to raise core Tier 1.

November's perpetual non-call 10 non-step pref share was followed at the beginning of March by a non-call 15 that, unbeknown at the time, caught the absolute market tights. The subsequent inevitable sell-off when conditions turned sour was exacerbated by the fact that its size (€1.4bn), contingent liquidity, long duration and, of course, the fact it was still primary and offered itself as the perfect market proxy.

A spread that more than doubled (from Bunds plus 102bp to well into the 200s) hardly laid the perfect foundation for future repetition of the concept, although without those trailblazing transactions that prove – if nothing else – that demand existed, it is debatable whether HBOS would have launched its £750m sterling issue – an exercise that saw it target the retail network as well as the institutions that had been earmarked as underpinning the concept – or whether Anglo Irish could have done likewise for its £300m.

Barclays Capital had a lead management hand in both those transactions, and an eventual sterling offering from Barclays Bank was almost inevitable. It arrived in early June (£750m of perpetual non-call 12s), but not before it had tapped into the US market for US$1bn with a groundbreaking non-call 30 transaction.

The sterling deal surprised in as much as it launched while Anglo was still primary and priced back of lower rated HBOS. This encapsulated the mood of the market, however, where issuers have to seize their opportunities. As JP Morgan's head of European FIG originations say: "it is all about psychology and momentum."

Even if borrowers have to make small allowances to ensure Tier 1 placement, the bond markets are still benefiting from a continued fund management bias away from equities. Case in point is Lloyds TSB, whose ordinary shares are yielding around 7.50%: on the other hand, Barclays and HBOS placed their prefs in the low 6%s.

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