Saturday, 22 September 2018

We’ll pay you

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  • The headquarters of Fresenius

Structured equity bankers proudly boast of the maturing of the market in Europe. Before the crisis, it was all over-engineered bonds placed with specialist hedge funds. Nowadays, it’s vanilla issues sold mainly to long-only investors.

The evolution has made bankers’ lives simpler – there’s less structuring work to do – and improved terms for their clients.

Pre-crisis, the market was slave to hedge funds’ pricing models. A theoretical value of 100% or more, and they were in. That made pricing easy, but not always compelling.

In recent years, though, banks have been able to squeeze investors beyond theoretical value – thanks to the presence of those long-only investors, who also assess a company’s equity story. In 2014, six par deals came with theoretical values of below 98, according to Deutsche Bank valuations. Healthcare group Fresenius achieved the best terms when it raised €500m from five-year paper valued at 94.99% of its face value.

But as yields have fallen, the strength of the long-only bid has become more problematic. Outright investors are not comfortable with a yield below zero. As a result, January – typically a busy month – came and went without a single new issue.

Unilever scoring seven-year paper with a 50bp coupon at the end of January in the straight debt market was the wake-up call equity-linked investors needed. Last week, RAG Stiftung issued €500m of five-year exchangeables with a minus 0.17% yield. After being beaten up for a month by the straight debt market, the equity-linked side has begun fighting back.

What could appeal to a CEO’s ego more than being paid to issue debt?

More from less

Commerzbank had a standout year in equity capital markets in 2014, with revenues understood to be just a few million euros shy of the best year ever. Somehow, the bank is managing to earn more from less.

Few firms have cut their investment banks as aggressively as Commerzbank has done, and the inevitable consequence has been its slide down the European ECM league table.

In 2000, it ranked sixth in Europe after leading 46 transactions. By last year, the bank had slipped out of the top 10, having worked on only 16 trades. It came just ninth in its home market.

And yet revenues are booming – and the investment bank is delivering a 16% return on equity.

Slots on big-ticket capital raisings by financials were essential to that success, as the bank found a role in deals including Deutsche Bank, Banca Monte dei Paschi di Siena and Banca Carige. Such deals are not labour-intensive, which allows for a small ECM team. Often a good balance sheet is enough to get into the tent.

Those who have questioned the longevity of a business built around bank rights issues should consider that financials are now consistently the largest source of issuance in European ECM, and there is no sign of that changing.

While it has been hard to watch Commerzbank’s retreat, particularly in its home market, its strategy is clearly working – more successfully than most would have predicted.

Communication failure

The drama surrounding Chinese property developer Kaisa Group is far from over, but it is already abundantly clear that poor communication made a bad situation even worse for international investors.

Kaisa’s offshore creditors, with about US$2.5bn of obligations at stake, were rocked by the company’s announcement in early January that it had failed to repay a tiny loan from HSBC that became due when its chairman left on December 31. The bank quickly granted a waiver, but not before Standard & Poor’s slashed Kaisa’s rating to “selective default”, forcing some fund managers to sell out at the bottom.

Kaisa’s bonds, having been close to par in early December, changed hands at less than 30 cents on the dollar, before rebounding to close to 80.

Investors are understandably upset. The significance of the chairman’s departure was not made clear in December, leaving them unprepared for Kaisa’s announcement and S&P’s subsequent downgrade. Better disclosure could have prevented some of the pain, but the lack of information is another reminder of the risks associated with Chinese investments.

Rumours abound in China’s capital markets, and companies are often too slow to confirm or deny reports that could have a material impact for investors – especially when the news is bad.

Ironically, transparency in the Chinese property sector is already much better than in other industrial sectors. Investors have access to monthly sales data, and most offshore issuers make a point of engaging with their overseas backers.

One Chinese property CFO last week admitted that the company’s chairman was now attending every analyst presentation simply because investors had asked so many questions about his whereabouts.

Kaisa’s management vacuum, with the chairman, vice-chairman and CFO all departing in December, doubtless contributed to the confusion.

The real lesson for investors, however, is that they cannot discount the chance of a nasty surprise. When things go wrong, bondholders must be prepared to find their way in the dark.

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