IFR DCM 2011

US high-yield bonds have been among the most resilient fixed income asset classes since the Lehman crisis. While leveraged loan supply continued to plummet until the Federal Reserve’s quantitative easing programme put a floor under credit risk appetite in 2010, the high-yield bond market has grown each year since 2008, according to data from Thomson Reuters.From a low of US$39.4bn across 95 reported trades in 2008, US high-yield borrowers issued US$145.7bn in 2009. A combination of negative real interest rates, more asset purchases by the central bank and improved corporate fundamentals drove high-yield issuance to US$263bn from more than 540 transactions in 2010, its highest ever level. Furthermore, investors shrugged off European sovereign contagion concerns to absorb another US$181bn of new risk this year, equivalent to a year-on-year growth rate of 20%, according to Thomson Reuters.Although the volatile summer has undermined primary and secondary market momentum, and US high-yield spreads have widened by some 250bp from the annual tights of Treasuries plus 500bp set in April, investors maintain that the market got it wrong. Ann Benjamin, head of leveraged asset management at Neuberger Berman in Chicago, manages a US$18bn leveraged credit portfolio. She says default rates will remain below the long-term historical average for the next few years at least.“Clearly the market has been volatile and spreads have widened significantly over the year but it continues to present a strong value opportunity. With spreads at plus 750bp, the market is pricing in a high default rate which we don’t think will materialise,” she says.Flow slowsNotwithstanding corporate America’s robust fundamentals, with spreads giving up most of their gains of the past twelve months in recent weeks, and tight conditions in primary and secondary markets, high-yield is now focused on the systemic consequences of a potential Greek default.After a forebodingly quiet summer, with no new issues in the last two weeks of August, the prognosis for the remainder of the year is a difficult one. Despite qualified enthusiasm for the first deals of September, including an increased seven-year from Double B rated healthcare provider Fresenius Medical Care, which cleared at the tight end of guidance at Treasuries plus 533bp, dealers are unlikely to seriously test market liquidity and risk appetite until the headline risks are either dealt with or recede.Indeed, while the US leveraged loan forward calendar included more than 30 transactions worth more than US$13bn at the beginning of September, the bond market expects just one new trade from Single B rated manufacturer JELD-WEN, according to JP Morgan high-yield strategists.“The primary market slowdown has been greater this summer than normal, and we have seen the lightest new issuance in August since 2008. We are looking for a pick-up in activity and only time will tell if that’s too optimistic. The market needs the headline risks to move to the backburner, and once investor confidence around the outcome in Europe improves, new issuance activity should also resume,” says Peter Acciavatti, head of high-yield strategy and research at an investment bank in New York.Europe vs USOf the two headline risks sapping investor confidence, Europe has the greatest potential to derail the high-yield risk-on rally. Although US macroeconomic data continue to disappoint and have increased the likelihood of a double-dip recession, high-yield borrowers have made extensive use of the strong bond and loan investor demand to refinance capital structures and deleverage balance sheets.JP Morgan estimates, for example, that leveraged finance borrowers have applied as much as two-thirds of the total bond and loan proceeds of the past three years to refinancing, with less than one-fifth funnelled into acquisition finance or LBO activity. By comparison, leveraged credits used more than 50% of bond proceeds to finance LBO activity in 2007.The Europea

Banks have piled into the asset class over the past year, boosting teams, raising leverage, underwriting on aggressive terms and bringing riskier Triple C rated credits to the market – to challenge industry leaders Credit Suisse and Deutsche Bank for a bigger slice of the fee pool.But the sovereign-inspired freeze in debt markets may help determine who has the staying power over the long term, and separate the leaders from the laggards.Goldman Sachs, for example, has hung on to second spot in the Thomson Reuters high-yield league tables since April – its highest ranking since 2003 – while BofA Merrill has also entered the top 10 table and Morgan Stanley has increased its market share by about 1% since last year.Other relative newcomers, such as HSBC, Nomura and Societe Generale, have also joined the party. But underwriters are now on the hook with an €11.5bn mass of unsold leveraged loans following a rapid retreat in risk assets by investors after the music stopped two months ago. About €4bn of that backlog is expected to be funded in the bond markets, which has been closed for two months with the exception of one bond deal from high-yield darling Fresenius Medical Care.“Until banks clear some of the backlog that they have on bridges, it’s going to be hard for those banks specifically to be very aggressive and to underwrite new deals,” said Kevin Connell, managing director of European high-yield syndicate at RBS.The new unstable environment – driven by fears outside of high-yield factors such as the eurozone sovereign crisis and economic growth – has cast uncertainty about the scale of potential bank losses on those bridge facilities and the sustainability of aggressive strategies to win business.Some bankers were keen to reassure that they were not suffering from this exposure at the Barclays Capital high-yield gathering in London in September. “The mere fact that they went out of their way to say that implies they are,” said an attendee.Investors are well aware that they can name their price as liquidity has dried up. “We would be interested in some of those LBO transactions. If they come at an appropriate discount, then we might be able to exploit a forced selling opportunity from a bank or underwriter,” said Anthony Robertson, head of high yield and distressed debt at BlueBay Asset Management.Clearing the decksThe debt overhang includes bonds planned for the buyouts of steel manufacturer Ascometal, cable businesses Coditel and Com Hem, Polish telecoms business Polkomtel, Swedish alarms group Securitas Direct and French mechanical engineer Spie on which banks committed financing between May and July this year.“The market was getting overheated in the late spring and summer, and transactions were either too leveraged or the credit quality was declining, reflecting very robust conditions at the time,” said Mathew Cestar, managing director and head of leveraged finance in EMEA at Credit Suisse.Credit Suisse has taken a more pragmatic approach, stepping away from underwriting deals unless they have been able to syndicate the risk, a source said. Up until recently, investors have been keen to take on some of this bridge risk to guarantee a better allocation on bond deals. A portion of the Polkomtel bridge has been syndicated, two sources familiar with that transaction said.Of the bond deals waiting in the wings, seven times leveraged Securitas Direct, is considered the riskiest and most aggressive. BofA Merrill, Goldman and Morgan Stanley – who have all boosted market share significantly – signed up for the Securitas Direct buyout financing along with HSBC, Nomura and Nordea.Those banks were helped off the hook with the €395m subordinated high-yield bond backing that deal after private equity firms Bain Capital and Hellman & Friedman struck a “club” mezzanine deal last month. But the underwriters may still lose money on a near €1bn senior secured bond yet to be launched.A doubling of credit index spreads since May also means

On the surface, the differences between the US investment-grade dollar bond market this year and last year seem trivial. But to dig deeper is to see two very different capital markets. For issuers and investors, the motivations are the same, but results are not.Somewhat inconceivably, this year the cost of capital in the bond market is generally cheaper and the returns on investment are growing.Total volume as of mid-September is just more than US$603bn, only about US$18bn shy of the same period last year. And once again, like last year, household names, Disney, Microsoft and Colgate-Palmolive, for example, are drawing the most attention from investors. And perhaps the greatest similarity between 2010 and 2011 is that the dollar bond market continues to be the most active and amenable capital market in the world.  However, the likeness, for the most part, ends there. This January, for example, saw the rebirth of a market for floating-rate notes which even optimists left for dead after the credit crisis and after banks, the most active FRN issuers, retrenched and curtailed historically abundant financing needs. Though the floater market tailed off a little near mid-year, when rates expectations shifted, volumes so far are several times greater than last year.In addition, Yankee issuers, particularly European financials, which drove so much of last year’s volumes, have hardly been able to find an audience in the US this year. There are some exceptions, such as the relative successes tallied by Daimler Finance and France Telecom in September, but the eurozone crisis has forced US investors to think twice before stashing away another European name in their portfolio.Perhaps the biggest difference, however, is one of quantity and not quality. One constant has been low coupons. But this year, aided by even lower Treasury yields, and no real signs that they will rebound, issuers are taking money out of the bond market more inexpensively than ever before. Last year, borrowing was cheap; this year it is measurably cheaper, and industrial corporations are taking advantage of the situation.The dollar bond market continues to be the most active and amenable capital market in the worldWhat’s more, they’ve had no real sense of urgency. They can pick and choose when to price new bonds and still get impressive rates: the reigning sentiment has been that great borrowing conditions will be here for a while.“In the primary markets, the supply doesn’t feel forced,” said Justin D’Ercole, managing director and head of Americas investment-grade debt syndicate at Barclays Capital. “It felt forced for such a long period of time – really for 18 months during the crisis – and it never feels forced now.”Mickey Mouse and Mc Donald’s break recordsWhile issuers are able to take their time, they are also racking up some remarkable achievements.McDonald’s Corp stepped in with a 10.25-year late last month which grabbed the top spot in the Thomson Reuters/IFR 10-year low coupon table, ousting previous record holder Walt Disney Company.McDonald’s hit the market with a US$500m SEC-registered 10.25-year notes offering due January 15 2022.The deal was whispered in the Treasuries +90bp area, but that was quickly whittled down 10bp to Treasuries plus 80bp area official guidance. Ultimately the trade priced at T+78bp (2.625% at 99.588 to yield 2.784%).Previous record holder Disney hit the top in five, ten and 30-years with its August 17 trade. In the 10-years, the Disney record was 2.75%. The market was ripe with possibility on August 17 when the A2/A/A rated Mickey Mouse purveyor went out to investors. Treasury yields all that week had been coming close to all-time lows. The benchmark 10-year Treasury yield, for example, fell below 2.00% and close to the 1.95% all-time low set in 1941.What’s drawn issuers to market this year is not necessarily a strong need for cash. The main allure was the ultra-low coupon rates.“A lot of issuers that have come to market don’t need

The scene from 18 months ago might as well be a fly-on-the-wall’s perspective of a trading floor today. But this time around, will companies – as in 2008 – rush to accumulate cash to build a buffer just to find that interest rates would have turned more favourable had they waited?It’s the treasurers’ call and up to them to determine whether we have learnt from our mistakes or whether history does just repeat itself after all. After Lehman Brothers filed for Chapter 11 bankruptcy protection following the majority exodus of its client base in 2008, issuers streamed to the investment grade corporate market, some paying as much as 9% in yields. Later credit spreads and underlying yields rallied meaning that funding would have been a lot cheaper had they waited.“I think corporates are better prepared now. They are stronger, leaner and meaner from a financial standpoint and can afford to be more strategic about it,” says Brendon Moran, co-head of corporate origination at Societe Generale. He brushes off fears that an entry into the market now may mean committing the same mistake as post-Lehman.“Corporates are taking advantages of windows of opportunity now because they can’t be sure that it’s going to get better before it gets even worse,” Jeff Tannenbaum, head of European syndicate at Bank of America Merrill Lynch said. “Waiting for an incremental day when the conditions are even better can be tricky and risky,” he added.Both Moran and Tannenbaum agree that bearing the long-term outlook in mind, and the persistent uncertainty, the time to go into the market might be now after all.Different this timeIn 2009 companies such as German retailer Metro AG and media company Bertelsmann AG jumped at the opportunity to secure liquidity in an uncertain environment, said Anthony Bryson, BNP Paribas’ European head of corporate debt capital markets. “What posed the problem was that corporates were pursuing the same aims at the same time,” he said.This time round the fundamentals have changed and corporates are facing a whole new set of conditions. The 10-year swap rate started 2011 at about 3.50% and having peaked at about 3.70% in early April. It has since steadily declined to current levels of about 2.50% when this report went to press. In 2009 the rate fluctuated between 3.25% and 3.70%.Corporates have manoeuvred themselves into a more strategic position now, scaling back capex, holding back on M&A activity and, in some cases, reconsidering their dividend policy. They’ve done their homework, one could say, but that does not mean that it’s plain sailing from here.“This year, the problem is that corporates have been able to become more complacent,” BNP Paribas’ Bryson said.“Equity ratios have improved, secondary spreads compressed and new bond offerings were oversubscribed at low new issue premiums.”When activity dried up in summer, market players resorted to the excuse that the vacation months of July and August were always quiet. “While there was zero activity in Europe however, we saw close to US$40bn in the US market in terms of investment grade corporate offerings,” Bryson pointed out.Moran also emphasised that August significantly changed the environment and led to the tactical concerns of treasurers around price and risk giving way to an increasing sense of being more pragmatic and more strategic about funding. Perhaps that was the warning sign the market needed to get itself back in the saddle.Strategy changeIn the current crisis, we are also challenged by the multiplicity of the situation. In 2009, a number of bankers, including Bryson, argue it was easy to pin the blame for the crisis on Lehman. The roots of today’s situation can be traced back to the US mortgage market, the European peripheries, or other public authorities. This uncertainty and feeling of a lack of control, he argues, is what could prevent issuers from going to the market now, meaning that they would regret it later.    As the market struggles to pick itself up a

They have been, indeed, so keen to adhere to the latest fad that some were willing to work virtually for free just to get a tombstone with a Real-denominated deal – with a couple of mandates having been given for a single basis point in fees.Everybody wanted to do one of these deals because they seemed to be where most of the future activity out of Latin America would be. The argument gained strength as inflows to local currency emerging market bond funds held up even as equity markets were selling off and investors were pulling out of riskier assets. And given that many Brazilian companies suffered during the credit crisis because of their exposure to the dollar, it was natural to assume they would love to issue in their own currency.But as the European credit crisis swayed markets, it became clear that the fad may have been short-lived and that there are several hurdles that need to be overcome before this market is fully established. One of the main bumps is the liquidity issue. The problem was underscored as some investors tried to reduce their positions on offshore local currency bonds during the recent market volatility and were unable to find buyers, even at deep discounts.“The lack of dedicated buyers is an impediment” for further development of the market, said Polina Kurdyavko, portfolio manager at BlueBay Asset Management. “For all of the foreign investors, it is an off-index bet in a highly volatile investment.”To make matters worse, deals denominated in Reais tend to be smaller. The first deals in this market were usually for less than US$300m equivalent. And while the last few deals priced before the market shut-down were larger, at an average size of R$1bn (US$532m), they barely made the cut as benchmark issues. That means that even as off-index bets, many important accounts could not participate in prior deals simply because they are obligated to only hold bonds with more than US$500m outstanding.Before the credit crisis spiralled in Europe, there was some talk about creating an offshore local currency bond index, and some asset-managers, as BlueBay itself, were creating specific funds to follow the new benchmark. That would partly reduce the liquidity concern.But as the uncertainty about the future of the eurozone increased, investors were painfully reminded of one of the main components of any equation to assess fair value of local currency bonds: FX volatility. While investors initially bought emerging market currencies and throughout July the Brazilian Real was less volatile than the euro, that quickly changed as risk aversion increased in August and September.By September 22, open-high-low-close volatility for the Brazilian currency soared to almost 34%, the highest since December 2008. For most of 2011, even during the swings caused by the tsunami in Japan and the Egyptian revolution, the Brazilian Real had traded in a range between R$1.57/US$1 and R$1.68/US$1, meaning its maximum variation was around 6.5%.But from the last week of July until the third week of September, the currency depreciated almost 18.5%.That threw out of whack all of the fair-value models being used by investors for local currency bonds. As one asset manager explained, to assess a potential investment in a local currency bond, they assume a certain volatility in the currency so they can evaluate if the coupon is enough to justify the additional risk.With a potential variation of 6.5%, depending on your entry point, it was not too hard to justify investing in a five-year bond of an investment-grade company at 10%. Even if the potential loss of having entered at the top of the range were incurred, the investor would still have a net carry of 3.5%, which, compared with the 0.8% that five-year US Treasuries were yielding by the end of September, seems amazing.And if the investor has a long-term view that the currency will appreciate further, the potential return could be much higher. “In the last two years it was much easier to create a

Slightly more than a year ago, China expanded its trade settlement pilot project and the Hong Kong Monetary Authority allowed offshore entities to issue bonds in the special administrative region (SAR), ushering in a wave of interest in the new offshore renminbi market.As the dominant investment option for investors in the offshore renminbi market, the volume of offshore renminbi bonds, known as Dim Sum bonds, has rocketed during the past 15 months.Investors have rushed to build exposure to the appreciating renminbi. That demand has kept the Dim Sum business ticking over even as global markets have slammed almost shut, with the past two months providing many examples of the Dim Sum market’s resilience in the face of global volatility.Resilient marketSince July 2010, an increasing number of Chinese and overseas banks and corporations have raised funds in the Dim Sum bond market, bringing the total outstanding stock of Dim Sum bonds to nearly Rmb165.6bn (US$25.7bn) at the end of August and is expected to touch the Rmb200bn mark by the end of 2011.The volume of Dim Sum bond sales more than doubled to Rmb43bn in 2010, and reached a new high of Rmb117bn (including CDs) in the first eight months of 2011.Despite the Muddy Water report on Sino-Forest and Moody’s “red-flag” warnings on Chinese corporate governance, followed by the US and the European sovereign debt crisis, deals have continued to be printed in the Dim Sum bond market.The Asian G3 high-yield market has been pretty much shut since June and the investment-grade market has been opened only for sovereign, quasi-sovereign names or top corporate names.However, Rmb64bn of Dim Sum deals were issued from June to August, which included Rmb41bn of corporate issuance and Rmb23bn from financial institutions.   Hong Kong remains the only place in the world outside mainland allowed to issue renminbi bonds and have a clearing centre for renminbi bonds in the HKMA’s CMU. Offshore investors can settle their renminbi bonds through Euroclear and Cedel, only because they have a link to the CMU system.Rmb FDI before year-endThe one hurdle to the growth of the Dim Sum market is the repatriation of proceeds to mainland China. Outside of banking and trade settlement, companies have little use for renminbi in Hong Kong and most of the proceeds from Dim Sum bonds have been remitted onshore. Chinese regulators, however, have yet to standardise rules governing the procedures for remittances, meaning issuers need to apply on a case-by-case basis for an approval that may take months to arrive.To tackle that, China’s Ministry of Commerce released for public consultation on August 22 a set of tentative rules on foreign direct investment using offshore renminbi Some market players believe a final version, which is expected before the end of this year, is pretty much set.Under the new rules, the MoC defines what constitutes “offshore renminbi funds from legitimate channels”, which include trade settlements, bond and equity fundraising offshore and “the allowable uses of proceeds”.Investments below Rmb300m will not need ministerial level approval, but investment above that threshold will need special approval from the MoC.Beijing will retain control over exactly what type of renminbi-denominated FDI is entering the Chinese economy, and in what quantities, according to a HSBC research report.Market players have welcomed the draft as it is a move towards establishing a transparent and standardised framework to allow offshore renminbi to be utilised onshore and to clear away the repatriation hurdle hindering the growth of the Dim Sum bond market.Reserve currencyDim Sum bonds have also seen investors rush to build exposure to the potential of the renminbi becoming a reserve currency in the future.It is no secret that China is moving to turn the renminbi into a currency for trade settlements first, then an investment currency and eventually a reserve currency.In September 2010, Malaysia became the first countr

Having recovered from the devastating March 11 earthquake, the relatively stable Japanese fixed income market was attracting a wide range of overseas financial institutions, its insulation from the deepening world problems offering a rich seam of investor diversification. Sentiment soured quickly, however, and the dream of accessing the market is now a distant memory for many.Global FIGs stormed the market in June, with European banks at the helm. As these financial institutions offered Japanese investors a better investment opportunity compared with what was otherwise available amid shrinking domestic primary supply, buyers lined up to take advantage of the pick-up on offer from well-known high-grade Western FIGs.The global sell-off in the aftermath of S&P’s downgrade of US debt to AA+ and the intensifying market talk surrounding European banks, coupled with the ever-worsening European sovereign situation, catapulted these volatile Western credits into the headlines. And as they fell out of favour with the cash-rich Japanese investor base, the Samurai market almost dried up completely overnight. In mid-September, overall Samurai issuance – the core funding tool for foreign borrowers in Japan – stood at slightly over ¥1.75trn (US$21.4bn) from 64 tranches, according to Thomson Reuters data, or about 85% of last year’s volume. While this was already more than the ¥1.55trn seen in the whole of 2009, more had been expected, especially from the financial sector.The right conditionsIn the middle of June, the market appeared to be offering the ultimate win-win scenario and this led to the largest monthly issuance volume since the FIG rush in September 2010. European banks were relatively new to the game, having only recently entered the yen market, traditionally a happy hunting ground for US banks – at least until the collapse of Lehman Brothers in 2008.However, a wave of negative events then conspired to derail several would-be notable deals. The perceived aggressive approach of Societe Generale, which saw it pin pricing down to a single number early on – an unusual mode of operation in this market that left it no room to manoeuvre when Moody’s placed it on review for downgrade – meant that the bank had to postpone its Samurai debut. Meanwhile, Bank of America’s last-minute cancellation of the ¥48bn multi-tranche self-led transaction that would have marked its first appearance since 2007 left bitter after-taste. However, while these events dented sentiment, they did not stop the FIG fundraising in yen entirely.What really stopped the investment flows was the significant deterioration in the major offshore markets following the sell-off after the US downgrade.With almost no tolerance for headline risk, Japanese investors watched in agony as overseas FIG secondary yen levels pushed out as a result of worsening global sentiment and worries about these institutions’ exposure to peripheral European sovereigns. Even so, there were no mass liquidations, although part of this could be explained by a relative lack of liquidity.“The US and European FIGs’ spreads are at pretty wide levels, secondaries are wide, CDS are wide. Everything outside of yen is wide, making it tricky for investors to bite. It would make accounts question the reasons behind such wide-level funding and make it seem a desperate measure, in turn deterring them from buying even more,” said one Tokyo-based syndicate head at a foreign house.“On the other hand, unless the top-tier European banks are really in serious need of funds they would not come out, say, at yen swaps plus 300bp. They would first approach their home markets through the likes of the tighter covered bond issuance we have recently seen, or other try funding methods.”Prior to the market freeze, well-recognised top-tier banks, such as RBS, Barclays, Credit Suisse, Deutsche Bank and UBS were suggested as potential candidates. Some had even soft-sounded the market earlier on in the year – sometimes on more

The region’s credit have printed 24 deals for US$15bn in the first nine months of the year, a decline of 61% compared with the whole of 2010. While three months still remain, bankers are predicting little in the way of new issuance as volatility continues and a high oil price relieves the need for the region’s discretionary borrowers to tap the capital markets.Emad Mostaque, a strategist for the Middle East and North Africa at Religare Capital Markets, said: “Looking back to the start of the year, the market dynamics were that oil was US$80 a barrel and that US$100 a barrel was a thing of the past. Now that a higher oil price is here to stay, there is little incentive for companies owned by oil-rich governments to seek additional funding, especially with investors demanding substantial new issue premia.”Hopes were high at the start of the year, when bankers were forecasting about US$30bn of issuance, and by the end of the first quarter, supply had reached US$7.9bn, more than double for the equivalent period in 2010, but since then there has been a dramatic fall. The start of the Arab Spring at the beginning of the year prompted prospective issuers to back away because they did not want to pay increased spreads caused by political turmoil in the region. The second and third quarters were more noteworthy for companies that pulled deals than for those which have tapped the markets.Plans on holdIn June, Etisalat, the UAE’s largest telecoms operator announced it had put its long-awaited US$8bn bond and sukuk programme on hold until at least 2012 due to political unrest after  shelving plans to acquire a majority stake in Zain, Kuwait’s biggest phone company in March.The Abu Dhabi firm is 60% owned by the Emirates Investment authority and its debt profile was seen as a proxy for UAE sovereign risk. While the programme’s establishment was seen as a critical part of its Zain acquisition plans, Etisalat has been linked with a DCM issue since July 2009, when it said it was targeting an MTN programme and benchmark-sized bond issue by the end of the year. A month later, Abu Dhabi’s Dolphin Energy Limited, 51% owned by state fund Mubadala, delayed plans for an immediate bond issue due to market conditions. Dolphin Energy completed investor meetings for a 144a benchmark dollar bond expected to raise around US$1.9bn but pulled it after the eurozone debt crisis and uncertainty surrounding Greece hit sentiment.The widening of spreads has been a concern for issuers in the Middle East looking to tap the bond markets,” Fabianna del Canto, director of emerging markets syndicate at Barclays Capital in London.  At least 60% of Middle East corporate bond issuance has been in dollars, meaning that while 10-year Treasury yields remain near record lows, investors have been demanding generous new issue concessions if they are to participate in dollar offerings.“The US corporate bond market is a leading indicator of where premia are heading, “ said del Canto. “While coupons are at record lows for dollar issuers, new issue premia for top-notch US investment grade names have been on the order of 30bp or more.”Also in July, Abu Dhabi’s Tourism Development & Investment Company developer of the emirate’s Guggenheim and Louvre museums, withdrew a bond issue while Dubai’s Majid Al Futtaim, the operator of numerous retail outlets in the Middle East, including Carrefour supermarkets, also shelved plans to sell debt the same month.One syndicate head at a US bank said: “The oil price was a big factor in TDIC shelving its bond deal.  It doesn’t need to fund.”  The postponement of these plans exacerbated the regions’ summer slowdown.TDIC is one of three quasi-government entities in Abu Dhabi that had been expected to start issuing bonds as it developed independent sources of funding. Mostaque said: “There is a desire to wean quasi-government entities off the government teat.”Market tap may be shut offHowever, bankers fear that quasi-sovereign entities could be pro

European banks are feeling the heat of the eurozone sovereign crisis and many are struggling to fund themselves. Although most have largely met their 2011 targets, there are real difficulties in securing short-term funding, and prospects for 2012 are very challenging.  Any equity offerings would face huge challenges, so the pressure is firmly on debt market solutions – and the choices are limited. With the experience of 2008 still very much in their minds, central banks will not allow short-term liquidity to disappear, but that does not deal with the underlying problems.The most worrying issues are the dynamics around the term funding for banks. The index of bank funding costs is above its previous all-time high – even above the levels of 2008. There has not been any significant unsecured issuance since the beginning of July. Bankers are increasingly pessimistic about the prospects for senior unsecured debt issuance from European banks resuming this year.The problem is a combination of issuers looking at the spreads required to get a deal away and investors being wary of buying, except from a small group of names.  Investors’ preference at the moment is to keep their heads well below the parapet.Shyam Parekh, head of EMEA FIG Capital Markets, Morgan Stanley said: “The bank term funding market has become a barometer for the sovereign and general eurozone situation. This could lead to a feedback loop where banks, because of their borrowing costs, have to restrict credit availability and then, as a result, further weaken the macro picture, exacerbating the sovereign dynamics.”There is a lot of talk about recapitalisation of European banks. The IMF is due to publish a major report this month. Increased capital is going to be an important part of restoring confidence and stability in general, especially in peripheral countries.Parekh said: “There is a perception that one can just add capital to the system and then the bank funding markets will automatically reopen, whereas it may not be that simple, given the issues around sovereigns, etc. Restoring bank funding may require a broader range of tools, including policy initiatives.”Most of the bank issues that came to the market during the summer and early autumn were covered bonds that were successful because of the level of protection that provided by the underlying assets. But the use of covered bonds eventually starts to impair the rating of senior debt, so this avenue of funding is limited, even in those jurisdictions where investors still have a ready appetite for the product.The situation in the senior unsecured sector is even more dismal. There were no major corporate issues in Europe from the last week of July to the second week of September. For the normally busy early autumn that was unprecedented and demonstrates how fragile markets are. Commentators are agreed that  if good strong corporates are not getting away, banks are going to be struggling.Short-term stand-offLooking at short-term markets for bank borrowing – which have recently received a lot of attention, especially for US dollar funding – there is increasing nervousness. However, there is a consensus that the situation is nowhere near as bad as it was three years ago.Morgan Stanley’s Parekh said: “If you look at the short-term repo markets, for example, they are by and large working well and, even more importantly, there are central bank back-stop facilities for short-term liquidity, whether in euros or dollars, such that we don’t see the risk of a complete drying up of short-term liquidity as happened in 2008.”There is a clear awareness among policymakers of the hard lessons learnt about liquidity drying up and an enormous focus on ensuring it does not happen again. In terms of long-term debt for European banks, 2011 to 2013 are the peak years for redemptions, with 2011 being the heaviest. That applies to senior debt, covered bonds, asset-backed securities, subordinated debt and some of the old government-guaran

Spanish government bonds began the year in a weaker position than Italian BTPs as investors began to fear the country with 20% unemployment would go cap in hand to the EU and IMF as Greece, Ireland and Portugal did.However, by August the two countries reached a point of parity as market fears were transferred to Italy. By September the situation had completely reversed and saw Italian BTPs quoted as much as 37bp cheap to Spain.Despite the volatile government market in Spain, covered bond issuers such as La Caixa, Kutxa and Caja Madrid were able to access the market with relative ease in the first half of the year and were looking forward to a year that would see them accessing the public market when necessary.But a lot has changed in the second half of the year. Covered bond traders now estimate certain Spanish issues that were sold earlier this year as are as much as 150bp wider than the level at which they priced. And it’s not just the second-tier names. By the end of the third quarter of 2011 even the highest quality bank assets are coming under pressure. A poorly received €1bn five-year covered bond issue for Banco Santander highlighted how investor appetite for Spanish names has changed since the country was hit by renewed sovereign concerns.In what is being viewed as a poorly executed deal, syndicates failed to sell all of the bonds and were long €125m each following the pricing. For the foreseeable future, covered bond bankers are bearish on Spanish names. “Even with as much as a 20bp new issue premium they still aren’t guaranteed the deal will be successful,” said a covered bond banker.Another syndicate banker echoed this: “If the market is shut you can add on whatever new issue premium you want and it won’t make any difference. I can’t see the likes of Santander and BBVA repricing their curve in order to access the market.”The failure of the Santander deal has been bad news for second-tier Spanish names in need of refinancing upcoming maturities. Months after the issue was priced, bankers are still concerned that the covered bond market will remain shut to smaller institutions for the remainder of 2011 and beyond.“The only way we can see an improvement in market conditions is with a common political response from Brussels”“Santander really disrupted the market,” said a DCM banker. “When you have such a badly managed deal it makes you wonder when we will see a weaker peripheral issuer come to the market.”Others are less pessimistic about the covered bond market and believe that the structural changes that are being made to the country’s cajas, or savings banks, are far reaching and will allow future issuance.“Spain is sorting itself out,” said Mauricio Noe, head of covered bonds at Deutsche Bank. “Covered bonds are the most important funding tool available to Spanish banks and I think we are likely to see a Spanish Cedulas issue price through the sovereign in the next 12 months.”Alvaro Jover, funding director at Bankia, agreed and said: “Spanish banks are fundamentally well capitalised. Speaking with investors, it’s clear that they are more concerned about the Spanish sovereign than they are about banks.”Access deniedOver the past three years covered bonds have been an important source of funding for Spanish and Italian banks, particularly for second-tier names that have been priced out of the senior unsecured market.Since the market opened in January, Italian banks have raised €12.8bn while Spanish banks have sold more than €18bn.In the Italian OBG market, up until June of this year banks had access to the covered bond market and were considered to be in a better position than Spanish institutions. UniCredit sold two OBG covered bond deals since June with a combined total of €2bn and Credito Emiliano also managed to sell a €500m no-grow in June.In the secondary market Italian names bucked the widening trend for most of the year but as the market began to focus on the sovereign’s 120% debt to GDP ratio covered bonds sp

The ratings agencies have not had an easy few years. The US Financial Crisis Inquiry Commission concluded that “the failures of credit ratings agencies were essential cogs in the wheel of financial destruction,” to the point that the “crisis could not have happened without the ratings agencies.”Yet their businesses are still thriving. Critics say the problems affecting the ratings agencies are deep and systemic. Issuers can shop for the rating they want, so ratings agencies will always be under pressure to win business by offering good ratings. This is more than just a theoretical problem.“Participants in the securitisation industry realised they needed to secure favourable credit ratings in order to sell structured products to investors,” said the FCIC. “Investment banks therefore paid handsome fees to the ratings agencies to obtain the desired ratings.“ The ratings agencies were under enormous pressure to win business, with issuers naturally desperate to influence them in any way possible. A product’s ratings have huge implications in terms of price and which investors can buy it, while at the parent level it determines borrowing costs. It would be naive to doubt issuers pressure agencies for a favourable outcome. But because the ratings process is so opaque, it is very difficult – if not impossible – to prove fraud, if ratings have been relaxed in order to win business.Even if rules are not relaxed in a cynical bid to win business, there is concern the agencies have grown too close to the issuers they analyse. It is a form of quasi-regulatory capture, said Eric Kolchinsky, a consultant at the National Association of Insurance Commissioners, and a former managing director at Moody’s. [♦Kolchinsky has a pending lawsuit against Moody’s.]When regulators spend too much time talking to a particular type of financial institution, their outlook can come to resemble that of the entities they are supposed to be policing. The same is to some extent true of ratings agencies, said Kolchinsky. Credit analysts spend so much time speaking to issuers that they can come to make similar assumptions about how they will perform in stressed markets, and what their ratings should be. “Its a bit like Stockholm syndrome,” said Kolchinsky. “If you spend that much time talking to issuers you start to see the world as they do.”The ratings agencies have acknowledged the problems and moved to address them. S&P identified four main areas it needed to strengthen to restore its credibility in February 2008, in the immediate aftermath of the credit crunch, when swathes of Triple A rated securities were defaulting: governance; analytics; information; and investor education. Moody’s identified six areas: strengthening analytical integrity of ratings; enhancing consistency across ratings groups; improving transparency; increasing resources; managing conflicts of interest; and pursuing industry and market initiatives.The Financial Crisis Inquiry Commission is blunter in its own list of failings identified at Moody’s, on which it based its case study, identifying “flawed computer models, the pressure from financial firms that paid for the ratings, the relentless drive for market share, the lack of resources to do the job despite record profits, and the absence of meaningful public oversight.”ComparabilityOne of the key tenets to the ratings agency philosophy is the importance of comparability. “When ratings are comparable across sectors, investors can better use them to compare the credit risk of securities in different sectors, thereby helping them to assess whether there are potential discrepancies in the pricing of credit risk in different sectors,” wrote S&P in a report in November 2009.“When ratings are comparable, an investor can more easily assess the yield offered by a bond relative to its risk as compared with other bonds from other sectors. We intend for each rating symbol – for example, AAA – to connote a comparable overall view of creditworth

As the role of the EFSF and the ESM has continued to grow, investors are now expecting higher returns from the EFSF as it becomes a more permanent feature of the SSA landscape. The EFSF was created in June 2010 to help resolve the potential sovereign funding crisis within Europe. Despite having a three-year operational life, the EFSF will exist as long as it has outstanding debt alongside its planned successor, the ESM.The EFSF sold its inaugural debut issue in January 2011. The transaction received one of the strongest receptions in memory from across the investor spectrum dispelling any doubts surrounding its ability to access funding. As it became apparent that more sovereigns were going to need assistance, the EFSF’s structure was found to be wanting and adjustments were made. The framework for the EFSF’s successor was laid out as it became obvious that Greece would have to roll over its first rescue package.The burgeoning needs of Europe’s sovereigns have, however, already made the group one of the largest bond issuers in Europe and while the spreads of German issuers have tightened, the EFSF’s spreads have widened in the secondary market.Origins of the EFSFThe inability of Greece to service its outstanding debt and to raise finance in its own right in April 2010 led the sovereign to seek assistance from both Europe – in the form of bilateral loans – and the IMF. Between them a bail-out package totalling €110bn was put together but at the time it wasn’t clear if Greece was an isolated case or, as is now known, just the first in the queue. This led European leaders to consider the unthinkable, the creation of a bail-out mechanism for sovereigns that had lost direct market access.The creation of the EFSF was the main outcome of those considerations, a fund backed by the guarantee of 17 member states which could provide up to €440bn of financing to any sovereign in need of assistance. Along with €60bn from the European Financial Stabilisation Mechanism, based on the budget of the European Union and a further €250m from the IMF, it was thought that €750bn would be enough to cover Europe’s needs and restore the faith of investors in the eurozone.To minimise costs and to ensure funding was at the cheapest level possible it was imperative for the EFSF to achieve a highly sought after Triple A credit rating and thereby position the issuer alongside comparable entities such as the EIB and the EU. The demands of the rating agencies to grant this rating, however, resulted in a much lower borrowing capacity and a rather cumbersome over-guarantee structure in which a certain amount of the €440bn was invested in Triple A securities to provide a buffer to neutralise the credit ratings of the weaker member countries.As a result, the effective lending capacity was cut to about €255bn and the questions of whether the EFSF’s “firepower” was enough to ensure its ability to support sovereigns in need were again rekindled. To address this issue an increased EFSF was proposed with the maximum guarantee commitments raised to €780bn, enabling a full €440bn to be on lent based on the higher proportion guaranteed by the stronger eurozone members.Market reactionWith the uncertainty surrounding the EFSF’s Triple A rating was removed, the inaugural issue on behalf of Ireland surfaced at the beginning of 2011. The spread differential of the EFSF to other comparable issuers was arguably the main test for the leads of the five-year bond sold in January.The transaction was handled by Citigroup, HSBC and SG CIB and carried initial guidance at mid-swaps plus 6bp–8bp which attracted more than 500 accounts into a stunning final book of €44.5bn. The final pricing of the issue was at mid-swaps plus 6bp and the issue went on to trade at minus 8bp in the secondary market as investors scrambled to top up their positions after the scaling back that inevitably resulted from such over-subscription.“The strength of interest in the issue ensured that any structural que