Smoothing the curves

To view the digital version of this report, please <a onclick="window.open(this.href);return false;" onkeypress="window.open(this.href);return false;" href="http://edition.pagesuite-professional.co.uk/Launch.aspx?EID=658d4d4d-e522-4d23-b5d0-33f6c4d2adaf">click here</a>. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com No stone unturned A year on from the last Top 250 Borrowers report and the issues that dominate the funding landscape remain largely the same as they did then. Concerns about the eurozone were at the top of the worry list and they are still there today, casting a long shadow that stretches far further than the continent of Europe. Sovereigns’ ability to fund themselves at a sustainable rate – or not, as the case may be – does not just affect the governments themselves; it has repercussions that resonate deeply for institutions domiciled within their borders. Banks find themselves tainted by sovereign woes, just as sovereigns find themselves drawn deeper into the mire by the state of their banks. And all the while, corporate borrowers look on with a sense of unease. But for every loser, there is a winner; although it has been the same select band of winners at almost every turn of the cards in the recent past. Funding costs for the US, Germany and the UK, for example, have hit historic lows, despite the former losing its Triple A rating from S&P last summer, while it has been the turn of Spain and Italy to flirt with the levels that undermined Ireland and Portugal. Each end of the spectrum can present its own problems, however. For those at the impaired end, this is naturally the cost of funding itself, as well as access on occasion, while for those perceived beneficiaries, it can sometimes be a struggle to convince investors to part with their money for so little return – Germany, for example, suffered a number of technically failed auctions, before yields took yet another leg down as eurozone concerns mounted. It is, however, self-evident which one is the more enviable position, and the knock-on effects on government-related issuers have reflected this. Fannie Mae, risen from the ashes of 2008 and with ties closer to the authorities than ever before, is now viewed as boring (and therefore sexy), while others largely reflect the state of their guarantors. As for the European supranationals, the reception they are afforded depends mainly on their perceived closeness to the centre of the eurozone crisis – a moving feast, if ever there was one. For the banks, however, much of the pressure was relieved by the LTRO initiatives, although there still remains the unknown of what will happen when the three years are up and a lingering suspicion that kicking the can down the road has become a central tenet of European policy-making. Meanwhile, those banks with market access and a desire to prove it have relied increasingly on secured funding in the guise of covered bonds, the senior unsecured market now virtually a ghost-town. With bail-in discussions regarding senior bondholder burden-sharing nearing a resolution, it is likely that the gulf between the haves and have-nots will become even more pronounced. And banks’ needs to boost capital ratios in the brave new world have affected lending decisions and changed the way in which the corporate sector operates. Loan volumes in EMEA at end-May, for example, were down 37% on 2011. While some banks have made an attempt to carry on in the hope of capturing ancillary business, much of the European landscape has a distinct pre-euro, more parochial feel about it. There are exceptions, of course, but the feeling is that major M&A deals will be few and far between and that it will be Asia that is more likely to throw up opportunities, as companies take advantage of low equity valuations for inorganic growth, such as was the case with Shanghai-based Bright Food’s play

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To view the digital version of this report, please click here. In an increasingly interconnected and globalised world, Asia cannot escape the effects of any crises in other regions. The eurozone crisis has been a huge overhang on financial markets and the resulting squeeze in liquidity has hurt many borrowers with the cost of funding rising to prohibitive levels. However, equity valuations have also taken a beating, and there are opportunities for bargain hunting that could lead to more M&A activity. “Asian M&A volumes have seen a resurgence in 2012 compared with 2010 and 2011. This year is clearly better in terms of number of deals and larger deal sizes as Asian corporates with strong balance sheets and a good following in the banking community look to make big-ticket acquisitions. Equity valuations are depressed generally and economic slowdown at home is forcing Asian companies to look at inorganic growth opportunities overseas,” said Birendra Baid, director, head of loan syndication, Asia at Deutsche Bank.Scrambling for a piece of the action The bank market is already salivating at a handful of big ticket M&A situations, including a scramble for a piece of the action on a £680m financing for China’s Bright Food, among others. At the time of going to press, more than a dozen lenders were vying for a lead role on the financing, which backs the Shanghai-based state-owned company’s purchase of a 60% stake in British cereal maker Weetabix. The huge interest in Bright Food’s acquisition loan is not surprising. The first quarter of the year hardly recorded any financing activity as the market began to feel the after-effects of the retreat of European banks from the region late last year. Moreover, with the Lunar New Year holidays in late January, even general lending experienced a slowdown in the first two months of the calendar year. “Asian M&A volumes have seen a resurgence in 2012 compared with 2010 and 2011. This year is clearly better in terms of number of deals and larger deal sizes as Asian corporate with strong balance sheets and a good following in the banking community look to make big-ticket acquisitions” “A general lack of corporate and project-style loans from Asia this year means that lenders are hungry to participate in M&A financings, which yield better returns. The outlook for the next two quarters for M&A financing from Asia is promising,” said Baid. Alibaba Group’s success in luring lenders – its US$3bn dual-tranche loan saw 14 banks committing US$2.5bn in syndication – proves that financings, if appropriately structured, can get done, even in tough market conditions. And this was a borrower from the internet sector making its debut in the loan markets.Sole underwriters a thing of the past Indeed, it also brings to light another dynamic. Multi-billion dollar loans now need a handful of banks underwriting them. Alibaba’s deal had six underwriters and it was at a US$4bn size in early December when it first emerged. However, tight liquidity and the rising cost of funding following the retreat of European lenders back to their home markets forced Alibaba to cut the size. The days of sole underwritten multi-billion dollar loans to back acquisitions seem to be over. Even blue-chip names such as Hong Kong Exchanges and Clearing, which is bidding for London Metal Exchange, mandated three banks for a US$2bn bridge. A loan of up to US$2bn loan for Tata Communications backing its bid for Cable & Wireless Worldwide saw five banks joining hands to underwrite the deal in April. The financing did not materialise after the Indian company withdrew its bid. This is a marked departure from the pre-crisis days when tens of billion dollar acquisition loans were put in place with individual banks underwriting huge chunks. Even in 2010 and early 2011, a couple of M&A situations such as Bharti Airtel’s takeover of Zain Africa and Vedanta Resources’ acquisition of a controlling stake in Cairn India led to

To view the digital version of this report, please click here. Only US$261bn of syndicated loans had been completed in EMEA by the end of May – 37% lower than the same period of 2011 – when US$415bn of deals were logged. The slump shows that companies are changing their funding strategy as the bank market gets less predictable. Banks need to boost capital ratios by raising equity, selling businesses or deleveraging and lending less is the easiest option. Borrowers know that loans will be less freely available and have been diversifying by raising debt in the bond markets. “It’s all about low volume; there’s just no opportunities. The overriding factor at the moment is the lack of flow and the major issue is getting deals in. It makes everything very difficult to call,” a loan syndicate head said. A quick look around would show a functional market, if on the quiet side, supported by strong liquidity. All deals launched so far in 2012 have sold well, which has created more downward pricing pressure, in contrast to a cautious late 2011. Thorny issues Scratch the surface, however, and more complex thorny issues surface through patchy data which show an increasingly fragmented and regionalised loan market in the throes of major change, that is grappling with numerous regulatory, macroeconomic and capital issues. “The market looks great right now from a borrower’s perspective; liquidity looks great. But banks have more fundamental problems than deals written this year would suggest,” the syndicate head said. Benign, if nervous, loan market conditions contrasted starkly with the broader capital markets as the eurozone crisis deepened again in May, when Greece’s exit from the eurozone looked increasingly likely and swathes of Italian and Spanish banks were downgraded. The intensifying eurozone crisis is putting a brake on lending. The second quarter is usually one of the busiest of the year, but volume was down 28% on the first quarter at the end of May, and the number of deals is down a whopping 58%. EMEA liquidity was eased by the European Central Bank’s long-term refinancing operation in February which allowed banks to continue lending. Many banks, however, are increasingly wary about underwriting liquidity that may not exist as the crisis deepens. “Going forward, you have to assume there will be a higher level of caution. The banks downgraded will have less capacity and the points around capital will crystallise quicker for banks downgraded. They will be aggressively selective,” the syndicate head said. Aggressive competition for scarce mandates and income has, however, forced some banks to waive fundamental questions around liquidity costs to keep doing business, and banks keen to maintain relationships with borrowers and grab ancillary business, are carrying on regardless. The EMEA loan market was expecting lower volume after much refinancing was brought forward last year, but bankers expected this to be offset by higher pricing. Rising volatility has however choked off M&A financing and the market is now facing the harsh reality of lower dealflow and pricing in a riskier environment. Frenzied bidding for debt packages such as the €2.75bn financing backing German utility E.ON’s sale of its Open Grid Europe gas distribution business was attributed to LTRO liquidity, which, although helpful, is postponing a long-anticipated pricing correction. “Pricing is idiosyncratic per market – we’re back to pre-euro pricing. We’ve moved from a euro market to more discrete markets” One bidding tree on the OGE sale received support from more than 20 banks and the unexpected success of the deal saw €250m commitments reduced to around €130m. Pre-euro pricing? The EMEA loan market has reverted to a series of local sub-markets with discrete pricing catering to domestic liquidity and supported by local banks, with the possible exception of Germany which has managed to maintain an international banking contingent due to the strength of

To view the digital version of this report, please click here. In May the European Financial Stability Facility took the unusual step of using an auction process for its €4bn May 2017 2% issue. While the use of auctions is nothing new for sovereigns – indeed, the syndicated market has all but been consigned to history as far as some are concerned – it was the first time a European agency had used the tool for something other than short-dated funding. The auction produced a successful outcome, with the bid-to-cover ratio at 2.7 on the €960m raised. However, some SSA bankers were up in arms about the loss of fees they would have received if the issue had been syndicated, and because they had dedicated sizeable teams to advise the eurozone rescue fund over the past two years. “We announced some time ago that we would look to tap existing bonds via auctions, and it is just another tool in the basket of the EFSF to increase its flexibility to access markets” They warned that the EFSF, which had proved a tough sell at times, risked undoing all the hard work in winning over investors if future, and potentially larger, auctions did not proceed as successfully. Critics say that the investor base for auctions – the dealer community – is much more volatile because banks have limited capacity to hold inventory on books. “It takes time for dealers to sell on those bonds to investors, and the risk is that the market turns, dealers panic and everyone hits sell at the same time,” said one SSA syndicate official. “Long-term, you need to build momentum,” said the head of public sector DCM at a UK-based bank. “This is especially true of credits with noise around them, ones that are in the middle of the storm.”Another string to its bow It does not appear, however, that this marks a fundamental shift in strategy as far as the EFSF is concerned, but merely offers another string to the facility’s bow. Indeed, the week after the tap, the EFSF returned to the syndicated format for its €3bn three-year new issue, in line with the approach promised by its CFO and CEO, Christophe Frankel, at the time of the auction. “We will continue to use the syndication format for new and large transactions but from time to time we will use auctions. For the moment, we do not plan to use auctions for new deals,” he said. “We announced some time ago that we would look to tap existing bonds via auctions, and it is just another tool in the basket of the EFSF.”A lot left to do And with more than €30bn still needed this year for bailed-out Greece, Ireland and Portugal this year, it is hard to criticise the fund for investigating all the options available to it. The borrower, rated Aaa/AA+/AAA, had made great strides in efforts to diversify its investor base already, having launched a short-term bill programme in December, as well as venturing out to the longer end of the market with a 20-year bond. The auction, therefore, was just another step in that direction. “They have a lot to raise and they need to be able to understand which products work,” said one SSA origination banker. “The T-bills have worked well and the syndication process is well established. The auction was an experiment to see how deep and well that vehicle can go because they need to know whether they can hit the market like a sovereign.” The benefits The debate about the merits of syndication versus auction is nothing new. Although sovereigns use both, agencies have never tested the market before. One reason for that is that agency bonds tend to be less liquid, making it more difficult for dealers to position themselves. The biggest benefits for the issuer of following the auction route rather than syndication are cost and time. “I don’t see why there has to be a hard-and-fast rule that auctions can only be done by sovereigns. Sovereigns use syndicated transactions to compensate banks that have supported them but also for riskier transactions that require a bookbuild process,” said one of the bankers.

To view the digital version of this report, please click here. When US insurance giant AIG was on the brink of bankruptcy in 2008, the Fed’s Maiden Lane III vehicle eased some of the insurer’s obligations by buying toxic CDOs from its counterparties. In exchange for being bought out at 100 cents on the dollar, the counterparties agreed to terminate the swaps. That deal was widely criticised as being a back-door bailout of the banks with which AIG conducted business. Now, as legacy US non-agency RMBS and CMBS have started to outperform the broader markets, those very same banks are battling each other to win bids on these now highly sought-after securities. Wall Street is winning a second time, critics say, as dealers buy the complex bonds back at a discount – and profit handsomely by flipping them to investors. A strong rally this year in the most battered crisis-era US non-agency RMBS has buoyed this broken asset class, generating tremendous secondary market interest in the sector, which is now considered a potentially lucrative long-term investment, offering rich loss-adjusted yields, sometimes up to 15% for some sub-prime bonds. Investors once again covet these distressed securities because they believe that the US housing market may soon hit a bottom, and bonds are often priced cheaply given that the beginnings of housing recovery might be under way. Not surprisingly, therefore, as the asset class outperformed equity and corporate credit during the first five months of this year, there has been keen interest in the Fed’s ongoing sales from its Maiden Lane II and Maiden Lane III portfolios of toxic mortgage-linked assets assumed during the 2008 bailout of insurer AIG, which cost US taxpayers US$182bn. The distressed securities helped bring down AIG, then the largest US insurer, and are largely backed by the kinds of toxic residential and commercial mortgages that came to symbolise the financial crisis. Yet this year’s sales of these assets from Maiden Lane II and III have been a resounding success. This success represents a complete turnround from one year ago, when the Fed’s open, public auctions of RMBS from Maiden Lane II saturated the market to the point where supply could not be absorbed, helping to trigger a capital markets swoon – coupled with uncertainty over the eurozone crisis – that lasted the rest of the year and pounded down prices on the bonds as a risk-off environment ensued. Given the waning demand for the securities and the supply problems they caused, the Fed immediately halted the Maiden Lane II sales in June 2011 after nine auctions, saying it had no set timetable to liquidate the remainder of the portfolio, and would only continue if it generated “good value for the taxpayer”. The district bank was wisely biding its time, and would only start selling again when it made sense. It made sense again in January this year. A rally in risk products that started in December, after the LTRO was announced, is all that it took. New strategy This time around, the Fed changed its tack for selling assets from Maiden Lane II: based on reverse enquiries, it would now only offer the securities to a limited group of hand-picked broker-dealers who would place competitive bids for securities they were hungry to acquire. The change in strategy has worked. After three more auctions early this year, the district bank finally completed its liquidation of the US$39bn Maiden Lane II portfolio of RMBS, with a net gain to US taxpayers of US$2.8bn. And since April, it has so far used the same strategy to conduct four limited auctions of CDOs from its US$47bn Maiden Lane III portfolio. Competition has been fierce for these securities. Banks are squaring off against each other to acquire the offered tranches, and in some instances even teaming up to offer stronger collective bids. But as with all things on Wall Street, there is a strong profit motive here: banks lined up their own bids from groups of investors prior to each auction,

To view the digital version of this report, please click here. Other debt markets have been bounced around by volatility, but the global sukuk market has seen growth, tightening spreads and is now looking beyond its natural homelands to new markets across the Asia-Pacific region. To put that into perspective, global sukuk issuance totalled US$26.5bn last year. This year it is heading towards US$44bn – with 60% of that from Malaysia, according to HSBC data. There is no doubt that Asia is where the headlines are. “With the Projek Lebuhraya Usahasama Berhad M$31bn sukuk and the Tanjung Bin Energy Issuer Berhad M$3.29bn sukuk issued in the first quarter alone, we are heading for a record year in 2012,” said Wynce Low, director and head of DCM, global capital financing, HSBC Bank Malaysia. Both deals stand out and in some ways are at the core of traditional sukuk issuance which is used for funding infrastructure projects. The infrastructure deal from Projek Lebuhraya Usahasama Berhad equivalent to US$9.7bn is the world’s largest corporate sukuk to date. It comprised four tranches, two which were sold and two which were publicly placed. To give an idea of demand, the M$11.3bn portion, rated Triple A by MARC, and which was itself made up of 15 tranches offering tenors from five years to 19 years, saw a book that was almost five times oversubscribed when it printed in January. “Malaysia is simply a more mature market. It has the most comprehensive legislative framework” Similarly in mid-March, the M$3.29bn sukuk for Tanjung Bin Energy, a jumbo project financing deal for the expansion of a coal-fired power plant in Malaysia, impressed investors. Made up of 31 tranches that stretched from a five-year tranche at 4.65% to a 20-year tranche at 6.2%, it proved there was still life in infrastructure projects. “Malaysia is simply a more mature market. It has the most comprehensive legislative framework. The combination of the two creates the situation today – more issuance and pick-up is inevitably better than before,” said Badlisyah Abdul Ghani, CEO of CIMB Islamic Bank. And there is a growing maturity in the market that is putting the difficulties of 2010, the taints of Dubai’s debt restructuring and a couple of embarrassing sukuk defaults, behind it. At the end of June last year, Malaysia’s US$2bn sukuk hit orders of US$9bn. The US$1.2bn five-year tranche priced at Treasuries plus 145bp while the US$800m 10-year portion went for Treasuries plus 165bp – 2.991% and 4.646% respectively. The former printed 5bp inside the outstanding curve. And when Indonesia came in November, its US$1bn seven-year deal was more than six times covered and paid only 4%, a negligible 20bp new issue concession over the sovereign’s conventional curve. So what is the attraction of the asset class? First and foremost it is straight supply and demand – that is where the money is. As Rafe Haneef, managing director of Amanah Global Markets, Asia-Pacific and chief executive of HSBC Amanah Malaysia, said: “If you are selling into a market where there is a dominant Muslim population, a straight bond might alienate 40%– 50% of fund managers. A sukuk issue doesn’t and, more to the point, commercial investors will buy it.” Malaysia is the fourth-largest bond market in Asia. Then, as significantly, sukuk issues have become a cheaper way to borrow money. The premia that borrowers have traditionally had to pay has slowly eroded. And you can see investor enthusiasm in that sukuk are trading tighter in secondary. Malaysian global sukuk are at 2.92%/2.736% and 4.57%/4.511%, while the Indonesia global above, has traded in to 3.7%/3.6%.China moves Given investor demand, it is unsurprising then that several other markets in Asia are also looking to tap into this market. First and foremost is China. The standout deal of the past 12 months – in symbolism if nothing else – has been the landmark Dim Sum sukuk sold by Khazanah Nasional, the Malaysian government’s investment holding arm, in

To view the digital version of this report, please click here. For many the internationalisation of the renminbi has been one of the most significant developments in the financial markets since the introduction of the euro. It is hard to disagree. Daily trading volumes in the US dollar and offshore renminbi now exceed the equivalent of US$2bn according to Deutsche Bank. Ever since the first issue of an offshore renminbi bond by China Development Bank five years ago, immediately dubbed Dim Sum bonds by capital market wags, more than 100 other issuers have followed suit. Everyone from the World Bank and HSBC, to McDonald’s and Volkswagen has rushed to take advantage of renminbi liquidity. Originally an issuance curiosity, the market is now far too big to ignore. The CNH fixed income market in the first quarter of this year saw a gross supply of Rmb80.7bn (US$12.7bn) and a net supply of Rmb71bn. That was a growth of 460% and 376% respectively, according to Deutsche Bank. The only way appears to be up. Dim Sum supply is expected to make up 50% of the Hong Kong bond market by 2015. “We now see more issuance in Asia via offshore renminbi than either the Singapore dollar or the Hong Kong dollar. This is now a legitimate currency for issue. It is clearly not the size of the US dollar market or the euro market yet, and in the grand scheme of things the market is still at an early stage, but it continues to grow quickly,” said James Fielder, head of local currency syndicate, Asia, global markets, for HSBC.Growing up What has changed is that the market has grown up. Dim Sum issuance is no longer frontier. It has moved front and centre and become mainstream. Perhaps the most significant change occurred in mid-March when Wen Jiabao, China premier, pointed out that the renminbi was close to its “equilibrium value” against the US dollar. Even last year a renminbi bond sale was a one-way bet. With the currency appreciating around 4% a year against the US dollar, even low bond yields were an investment no-brainer thanks to the currency pick-up. “Currency speculation has now been taken out of the equation,” said Herman Bake, head of global risk syndicate in Asia for Deutsche Bank. “Policy makers are saying that CNH and CNY are at equilibrium, and that is a fair assessment.” As importantly, regulation to help the offshore renminbi market develop has been put in place. More than half of the 13 major currency restrictions on cross-border currency have been deregulated already and in mid-May, the Hong Kong Monetary Authority continued with another one. Authorised financial institutions are now allowed to determine their own net open positions in renminbi. The cap had been set at 20% which was itself raised from 10% in January. “Regulation is heading in the right direction and it is moving faster than people expected it to. Remember that too rapid deregulation comes with its own problems,” said Mark Leahy, head of debt capital markets and debt syndication at Nomura International in Singapore. “Deregulation is a measured process,” said Aaron Russell-Davison, head of debt syndicate for Asia at Standard Chartered Bank in Singapore. “These steps are precisely what you would expect – we are moving towards the ultimate convertibility of a currency that will have a major impact on global finance; the pace should be measured because the outcome is so important.” Yet another milestone can been seen with the launch of the six new currency-trading pairs tied directly to the renminbi that HSBC launched towards the end of May. “Clients no longer need to go via the US dollar anymore, in the same way the euro/yen market is quoted,” said HSBC’s Fielder. The euro, the British pound, the Hong Kong, Singapore and Canadian dollars and the Mexican peso are all quoted directly against the renminbi. “We are moving towards the ultimate convertibility of a currency that will have a major impact on global finance; the pace should be measured because the outcome is so importa

To view the digital version of this report, please click here. Senior unsecured debt used to be cheap for banks to issue as investors focused on the bonds’ seniority, overlooking the fact that they were unsecured. Under proposals put forward by the European Commission, the senior unsecured debt of a failing institution could be converted into equity, significantly reducing the benefits of seniority while making unsecured debt particularly vulnerable relative to other types of debt, notably covered bonds. “The introduction of bail-ins is understandable given the scale of the financial crisis,” said Sebastien Domanico, head of FIG debt capital markets at SG CIB. “This is a political move aimed at comforting investors to continue and invest in bank paper while ensuring that everybody shares the burden, including creditors.” In his view, however, this tool is unlikely to be used since European banks that run into difficulty usually fall victim to a liquidity crisis rather than actual losses. But, according to the European Commission, a new resolution regime with extended burden-sharing is needed. The Brussels-based body pointed out that the level of state support to ailing banks deemed “too big to fail” has been unprecedented since the outset of the crisis and “it is clearly undesirable for public funds to be used in this way at the expense of other public objectives”. The Commission published on June 6 its long-awaited Crisis Management Directive draft, which is supposed to provide both more comprehensive and effective arrangements to deal with failing banks at national level, as well as complete arrangements to tackle cross-border banking failures. For holders of senior debt, the documents clarified several key questions that had been left open in previous consultation papers.Precise timing The timing, in particular, is slightly more precise. The Commission indicated that the bail-in tool should apply as of January 1 2018 to “all outstanding and newly issued debt”, both senior and subordinated. Over the past months, market participants had been debating whether the Commission would make all the existing stock of debt bail-inable. “Confidence and stability in the financial system will be enhanced when major banks that get into difficulties can be put through an orderly, internationally co-ordinated process to resolve their insolvency or illiquidity without creating destabilising systemic shocks” If this had been the case, investors feared that the measure could have kicked in well before 2018. But 2018 is more a suggested deadline rather than a starting point. BNP Paribas analysts noted that the phrasing of the proposal suggests that bail-in powers “could potentially be used as early as 2015, although the EU authorities recommend that they be used by 2018”. The Commission also recommended that at least 10% of liabilities be bail-in-able, but the final say will remain with each national regulator. At the big-picture level, the Commission’s proposals are viewed as broadly positive. Participants at the Institute of International Finance spring meeting in Copenhagen on June 7 suggested that these attempts to harmonise the EU’s banking resolution rules might reduce the need for other regulatory measures, in particular requirements that larger institutions hold greater levels of capital. “This is an opportune moment to consider whether there should be a pause in adding further to the aggregate of regulatory reform already in place and in train,” said Douglas Flint, chairman of HSBC, who also chairs the IIF. “Confidence and stability in the financial system will be enhanced when major banks that get into difficulties can be put through an orderly, internationally co-ordinated process to resolve their insolvency or illiquidity without creating destabilising systemic shocks,” he said. At a more micro level, things do not look so good because bail-ins will affect banks’ cost of funding and modify the characteristics of the bonds, thereby

To view the digital version of this report, please click here. Hopes of a revival in high-yield issuances have faded somewhat with bankers focusing on blue chips and the record low coupons they can potentially achieve as US base rates hit record lows as investors flee to the relative safety of US Treasuries. Yet constantly shifting sentiment has exacerbated execution risks in a market constantly under the threat of headline risk. Still, inflows into emerging market bond funds and dearth of supply in Europe mean cash has been accumulating on the sidelines and is ready to be put to work in high quality Latin American credits denominated in both dollar and to a lesser extent euros. Despite the dramatic slowdown in issuance in May, so far volumes on are on pace to meet last year’s total of US$91bn. The region had already seen more than US$45bn in cross-border bond issuance this year until late May, though activity has declined after a bumper January and February. Those two months saw combined volumes hit US$32bn. In contrast, May, April and May only produced US$8.2bn, US$2bn and US$1.4bn. The rush to print early in the year was driven partly by the numerous corporates that were sidelined last year and a sense that the environment in the international capital markets could potentially become more volatile later in 2012. Similar arguments were also applicable by the second quarter as concern about the fallout from Greece and Spain became more acute. “Volumes to date have surpassed last year,” said Katia Bouazza, co-head of global markets, Americas, at HSBC. “We told a number of issuers to come sooner in the year as we saw some additional volatility.” A senior syndicate official echoed similar sentiments. “Hats off for people who jumped in early. They correctly predicted that the scenario was too rosy for reality,” he added.It’s all Greek In May the buyside was firmly on the sidelines or sticking to safe liquid names until the second round of Greek elections on June 17 provide some clarity on the direction of European risk. “It is all Greek to me. That is what matters now,” said an investor focused on LatAm and other EM corporates. Until the middle of May, external debt funds had been seeing net inflows, which was a positive. But the latest EPFR data show that investors are becoming increasingly risk averse, with both hard currency and local currency funds seeing net outflows in the week to May 23. At least the build-up of cash positions should provide support to the primary markets if European policymakers can generate greater comfort levels. But some believe a more positive outcome in Europe may even result in a significant reversal of EM debt flows as investors become less risk averse. “At some point, if things start to look better, I’m sure we’ll see big reallocation out of fixed-income into equity,” said a syndicate manager. For now, markets remain open for investment-grade LatAm credits, which could still take advantage of low absolute yields, although new-issue premiums will be considerably higher. “New-issue premiums are 30bp or 40bp higher, but that is not a lot in the grand scheme of things,” said a syndicate official. LatAm DCM bankers have been keeping a close eye on the US high-grade market, which has had a mixed performance. For many a US$8.9bn multi-tranche offering from United Technologies was illustrative of the enormous amounts of cash on the sidelines and of how top quality LatAm credit could lock in ultra-cheap financing. “United Technologies’ blended average cost of funds across the six tranches was 2.90%,” said Clayton Pope, who heads Credit Suisse’s EM syndicate desk in New York. “A US$40bn book for an intraday execution is evidence that there continues to be a substantial amount of high-grade cash to be deployed, which is definitely there for storied LatAm issuers looking to fund at record low absolute yields.” But for now investor reaction to Europe’s debt crisis will probably be the principal driver o

To view the digital version of this report, please click here. Priceline.com, rated Triple B, was the first of several issuers to tap into unmet demand with a US$875m, six-year unsecured CB in March that featured a 50% conversion premium; at the time among the highest premiums in years. Equally impressive was the ultra-low 1% coupon paid for the liquidity bump, making the CB a compelling alternative to straight debt. “We had seen very little issuance when this deal was done, particularly by investment-grade companies,” said Jason Lee, global head of equity-linked solutions at Goldman Sachs, sole bookrunner on the Priceline CB. “A lot of the existing investment-grade paper was issued in 2005–07 timeframe, and a lot of that had rolled off.” The declining market for convertibles has largely been driven by insufficient supply. From an all-time high in 2008, the size of the convertible bond market in the US has shrunk from US$350bn to about US$200bn, and the investment-grade component of the universe has fallen from 45% to 25%, according to analysts at Barclays. The major reason for the decline is that persistently low interest rates, dating back to quantitative easing that began in 2008, has made it more compelling for companies to simply sell debt rather than debt-plus-call option (a convertible bond). Total issuance of CBs in the US last year fell from US$34.8bn in 2010 to US$24bn, as compared with high-yield volumes of US$223.7bn in 2011. Year-to-date issuance through May of US$7.7bn puts full-year CB issuance at US$18.7bn. Accounting changes that went into effect at the end of 2008 also served to make convertible bonds less attractive than straight debt, particularly for investment-grade companies. Specifically, companies were forced to bifurcate net-share settle convertibles, by separating the security into equity and debt components and flowing through interest expenses on the income statement at the cash-plus-accreted rate rather than the actual cash interest paid out to investors – effectively undermining the cash saving of a CB versus straight debt. While the accounting change had no effect on cashflows, it suppressed earnings per share. Logic suggested that if companies received no benefit, then they might as well look to straight debt funding, particularly for large, rated companies. Technology companies are an exception.The chase Priceline was in many ways the perfect candidate for a convertible bond – an investment-grade credit, growing fast and with a volatile share price. The company had been pitched by banks on various financing alternatives involving a CB over the past couple of years, allowing it to run a competitive process. Goldman Sachs accelerated discussions by offering to backstop a deal at the 1% coupon and 50% conversion premium. Other banks that previously had pitched for the business were invited to submit bids at a lower coupon, with the conversion premium fixed and a commitment to repurchase US$200m of stock in conjunction with the placement. Bank of America Merrill Lynch and JP Morgan, which teamed up on a US$575m, five-year CB for Priceline in March 2010, were among the shortlist of banks also invited to bid, according to various market sources at the time – such competitive processes became increasingly common for coveted issuers, further highlighting a market starved for supply. Rather than being backed into a corner, as rivals had hoped, Goldman had little trouble attracting investor interest. The bank marketed the deal on an overnight basis at 98.5–99.5 at the fixed terms, before finalising pricing at the top end of that range. It subsequently exercised its overallotment option to increase the total size of the funding to US$995m. Significantly the majority of the offering was placed with long-only outright investors. “We saw significant interest from outright buyers, both in the US and Europe,” said Lee. “A lot of buyers in Europe are orientated toward investment-grade paper because of their ch