Familiar models, new fashions

IFR Top 250 2014
19 min read

Bond market conditions are as tempting as ever for borrowers, but can DCM and other sources of capital rise to the challenge of meeting the evolving market environment driven by regulation, deleveraging and a more conservative approach to bank lending?

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If debt capital markets are on the verge of a major structural transformation, the evidence is unlikely to be seen in IFR’s list of the world’s Top 250 borrowers. What the tables show this year is that the world’s leading borrowers are broadly the same sophisticated set, many with programmatic borrowing needs, that has graced the list for years. That’s unlikely to change, even if current bond market conditions are as tempting as they’ve ever been.

The tidal wave of investor liquidity unleashed by monetary stimulus and its resultant ultra-low rates, which set in train a frenzied hunt for yield, created – by definition – a near-perfect set of conditions for borrowers. It’s a seller’s market out there, an element not lost on the issuer community.

While this is something of an old story, it’s one that has nonetheless seen everything catch a frothy bid, from peripheral European government bonds, all corners of the global credit and high-yield market (including issuance at the more shadowy ends of the capital structure) to CLOs/CDOs; covenant-lite loans; distressed debt, commercial real estate and more.

“You used to be able to get a return on your money by buying a risk-free asset; now it’s very hard. In the safest of the so-called risk-free markets you may well be earning negative interest rates,” said Charlie Berman, chairman of EMEA DCM at Barclays.

“The markets are more transparent and there is clearly less layered complexity [than before the crisis]. Investors have risk appetite as long as they can understand what they’re buying. That’s what’s driving the desire to push out into places like Africa and elsewhere.”

Berman believes the current conditions will be with us for some time, although he does sound a note of caution, saying: “I think it would be a brave person who would call a return to rate volatility any time soon, so from an investor’s point of view, how are they going to make money? They’ve got to make money by taking a view, whether it’s in corporate or sovereign markets, or whether it’s with the banks, where we’re seeing all forms of capital now being enthusiastically purchased.

“But I think the system has a number of issues that people need to be very wary of. The fact that the ECB is talking about QE is a measure of the problems out there, so I’m not saying everything is fine and we’re off to the races and anybody can buy anything they want. Far from it. What I’m saying is that people have to get on with their lives. Investors are typically responsible for other people’s money and they have to apply that money to get a return because cash rates are zero.”

On current technicals, high, and in some cases unseemly, levels of oversubscription for new issues and super tight spreads suggest we’re close to or in bubble territory. Bearing this in mind, we should perhaps be less impressed by the US$3.2trn quantum of debt raised by the IFR Top 250 over the 12-month qualifying period (May 1 2013 to April 30 2014), which in this context can be seen as rather unremarkable; certainly unsurprising.

By borrower type, about 29% of IFR’s 2014 Top 250 hail from the SSAR sector, 23% from FIG and the rest – 48% – are corporates, with debt totals related both to general corporate purposes and refinancing as well as event-driven activity. Speaking to the latter point, Verizon leads this year’s IFR Top 250 with US$140bn of borrowing to its name over the qualifying period.

Changes afoot

So far so good, but there are a number of seminal changes afoot that could drive a potentially permanent sea-change in the make-up of the capital markets in terms of who the borrowers are – certainly in Europe – but also what the debt capital markets are actually used to finance.

If current technicals represent the old story, the new story is whether and how DCM can rise to the challenge and re-invent itself to suit the new and emerging ecosystem, one driven by the new banking regulatory framework and its linked themes of deleveraging and strategic re-positioning by banks. These themes are certainly occupying the minds of the industry.

There are numerous sub-themes. The rise of Green bonds, although a still embryonic segment of the market, has taken the debate about sustainable finance to the centre of the capital markets community. The, perhaps bigger, theme is whether what was once seen as specialised bank risk can be distributed in the bond market as banks fine-tune their originate-to-distribute business models.

This theme encapsulates the huge issue of project and infrastructure finance, as well as trade and export finance, real estate, commodity, even aerospace and transportation finance, where bundled, tranched or otherwise receivables-based solutions are certainly within the realm of the possible.


In Europe, it’s SMEs, the beating heart of corporate Europe, that are front and centre of the putative in-process transformation of corporate funding. This issue bears some deeper analysis. In total, 140-plus corporates made it into the IFR Top 250, and each issuer borrowed in excess of US$5bn to get there. The latter point pretty much tells a story.

Even looking beyond the Top 250 rankings, the Thomson Reuters list of European corporates that tapped the bond market in euros between January and early June 2014 shows that 165 household names accessed the market across investment-grade and high-yield markets, raising €134bn. A further 35 or so well-known names tapped the US dollar market, mainly high-yield, for around US$36bn in proceeds on top of that. Beyond this, a third or more of this year’s US$45bn in US private placement supply will come from European issuers.

The point is that DCM will have played host to fewer than 250 European corporates in the first half of the year. But Europe has millions of SMEs. Even taking out the micro-caps, for which the bond market will never be a viable funding option, still leaves hundreds of thousands of companies in theory entering the realm of the bond market, most for the first time.

It’s noteworthy that only a dozen issuers took less than €100m out of the market while five times that number raised more than €1bn. It’s a similar story with European issuers in dollars: only half a dozen came away with US$100m or less, while 22 borrowed more than US$500m. Even the USPP market, driven by frothy demand, is about size these days. Belgian healthcare provider Arseus sold its multi-tranche dual-currency debut USPP in April. Initially targeting US$100m, the company ended up issuing US$185m.

Household names in size

And that’s the point: the DCM story is really about household names selling debt in size. The market for European corporates continues to be very lumpy. Even if you bear in mind that Thomson Reuters data exclude the majority of US (and the small number of European) private placements, MTNs, Schuldschein, etc, the stratification of the non-bank corporate bond market tells the story of a market perhaps ill-suited to the needs of most European mid-caps.

While it’s undeniable that there’s been a distinct increase in the level of debut and/or unrated issuance from European corporates graduating from the loan and other markets, including convertibles and private placements, most issuers are too small to access the bond market in anything like the size at which the documentation, preparatory work and transparency make it a worthwhile exercise – bearing in mind they’re hardly going to be regular issuers.

But if you buy the thesis of a funding shift in the first place – and it’s a story that has garnered significant support in the past year – it’s here where the changes afoot in the European capital markets will need to take place: at the level of SMEs. This will be a challenge.

Attempts by stock exchanges throughout Europe to attract bond listings and channel retail buyers into corporate debt have been poor at best – notwithstanding the benefits on paper of the price discovery and transparency provided by an organised marketplace – and have largely been considered a failure.

The liquidity constraints that had prevented most SMEs from tapping the bond market have certainly changed – liquidity has collapsed as capital constraints have destroyed dealer inventory. The agenda as to how European corporates access funding is a live one, but it may be a stretch to concur with those who talk of Europe quickly adopting a similar model to the US, where corporates head to the bond market first and to the banks as a distant second.

“We’ve been talking about this for 15 to 20 years and quoting the same statistic – 20% of US bank balance sheets are loans and the rest is financial instruments, and in Europe it’s the reverse. We’re still saying the same thing. There’s a long way to go before the international capital markets look like the US, where a much earlier-stage call is raise money from the capital markets,” Berman said.

Policymakers’ quandary

“The issue is: How efficient is the system in getting money into the SME segment? Huge amounts of time are being expended in Europe on how the system transmits money to SMEs to fuel growth. It’s a quandary for policymakers because the desire for them to fuel growth is not necessarily consistent with the regulations that are being applied to lending from a bank point of view. I think what one can say is that the capital markets in which we operate will continue to diversify, and open up to new ideas and instruments.”

Daniel Sachs, CEO of Proventus Capital Partners, the European credit investor and loan provider based in Stockholm, reckons that the split between bank and non-bank funding will end up being lower in Europe than in the US.

“Banking will continue to be more important in Europe than in the US. When it comes to leveraged finance or buyout funding, we’ll never get to the 90% non-bank levels we see in the US. In some segments of the market, Europe is seeing a 50-50 split, but relationship banking is still an important driver.”

Of course, other funding sources include not just the bond market or private placements. Securitisation; asset-based finance; to a lesser extent institutional crowd-funding; and non-bank institutional lending (aka shadow bank facilities) are all in the mix.

The latter in particular has seen a huge rise; not yet to a level that is moving the needle, but a segment in flagrant development nonetheless as banks enter into distribution partnerships with institutional clients or where clients disintermediate the banks by engaging in direct lending through bespoke funds.

A case in point: Proventus announced the first closing of its third fund at SKr8.8bn (US$1.3bn) in late May. The firm has hired Credit Suisse to market the fund to non-Swedish institutional clients. The target is family offices, endowments, foundations and pension money.

Disbursements will be targeted to expansion capital, acquisition financing, restructuring and refinancing for mid-caps throughout Northern Europe. A little over half the firm’s commitments to-date are in the Nordic markets, but the firm is also targeting the German-speaking countries, Benelux, the UK and Ireland. Some of the non-Nordic situations will have a Nordic angle or will be in industries in which the firm has been active in its home markets.

Maintaining the firm’s origins as a private equity investor, Sachs sees himself very much as a partner to the companies he’s lending to. He’s also looking at the same time for a chunky financial return for providing capital to companies that for all sorts of reasons may not be at the centre of the radar screen of traditional credit providers. The margins the firm charges are higher than standard bank margins but cheaper than equity financing, which invariably is the only realistic other option.

“We’re a complement to traditional sources of funding, but where we differentiate ourselves is we’re quite comfortable in complex situations, working with companies that may be under stress or in industries the banks shy away from,” Sachs said.

Funding tickets can range from €10m up to €125m, but the sweet spot is €25m–€50m. The firm has a hold-to-maturity approach and rarely syndicates its commitments. Around half of its loans are senior; 35%–40% are second lien with the rest mezzanine or junior facilities.

Will the banking model re-emerge?

The core of the structural shift, of course, which is creating space for institutional lenders, derives from a widely held perceived belief that balance-sheet lending by banks is on the wane as a result of regulatory and more specifically capital adequacy treatments, and that capital markets and those other sources of funding are going to take their place as banks rely less on leveraging their balance sheets in favour of the originate-to-distribute agency model.

One of the conundrums at play in getting to grips with the direction of travel in the bond market transformation process is that one almost has to discount current market technicals and the opportunism they encourage as being circumstantial.

In other words, ascribing every deal from a debut or unrated corporate borrower in the European bond market as evidence of an inexorable shift towards the US capital markets model and markets/bank lending stratification may be wide of the mark.

But it’s hard to ignore market realities. The early-June policy actions by the European Central Bank will enhance the appeal of the credit market and squeeze bond yields even more. For borrowers able to lock in current levels, the market is irresistible.

But while the ECB has chosen the task of slaying the bête noire of deflationary tendencies over and above any concerns it might have about its own actions and those of fellow central banks in fuelling a credit bubble, the real question is: When we get to a normalised stimulus-free yield curve and a higher rate structure, will the case for that much-vaunted structural shift in capital markets remain intact given the altered state of buyside and borrower incentives?

And if at that same point the cycle of bank deleveraging has reached an end-game of sorts and the European economy is showing signs of sustainable growth, what then?

A more “normal” technical backdrop will shake out a lot of excess liquidity and will force a reappraisal of the credit yields that in the eyes of many have reached unsustainable levels. A shake-out will lead to more realistic price discovery in the bond market and will therefore make comparisons with loan market pricing more believable.

A higher rate of economic growth and better levels of job creation will reach a tipping point at which it will perhaps make some sense for banks to open the credit taps to select corporate clients. The emergence of investment spending rather than consumer exuberance to secure growth could be a catalyst for banks to reconsider opening up their balance sheets; something that quantitative easing failed to do. All QE ever did was to fuel an exercise in financial arbitrage by institutional and wholesale players.

While the statistics gloomily point to significant declines in bank lending, there is evidence that banks are willing to put liquidity to work in favour of a slimmed-down core of relationship clients who understand the game and the imperative to imbue the core lending relationship with ancillary business. The zeal with which regulators – notably the ECB and the Bank of England – have set about trying to kick-start SME securitisation is expressly intended to encourage lending by providing banks with a lay-off channel to manage their exposures and regulatory capital requirements.

Relationship banking remains intact but has reached a more evolved state. “We’re no longer interested in subsidising loss-making loans with loss-making derivatives,” the divisional CEO of a major European bank said, with a wry reference to the old-style model of extending loss-leading loans in the slightly unscientific hope of being awarded ancillary business with no real way of calculating the returns of each client relationship.

A more sophisticated and fully costed ancillary play is now in train around selling the full suite of corporate and investment banking products to the client. Lending remains at the centre of this proposition.