Market eyes long-dated corporate debt

Financial News

January 4, 2004

Bankers have dismissed concerns that the fixed-income market boom, which saw bond yields rally spectacularly after the Iraq war last April, will halt this year.While yields underwent a huge correction in 2003, outstanding corporate bond redemptions of around [euro]50bn ($61bn) in the first three months of 2004 will leave room for a further rally, they say.

Julia Peach, global head of credit research at ABN Amro, said: "A strong bid for reduced new issuance will characterise the first half of 2004."

If innovation was the watchword of the European corporate debt market in 2003 as borrowers braved previously untapped sectors of issuance, the development of the long-dated debt market will be among the most keenly anticipated aspects this year.

The first 30-year bond by a European company was strongly welcomed in January 2003 when Olivetti, the Italian telecoms group, raised [euro]800m of 30-year bonds as part of a [euro]3.4bn transaction.

Other telecoms and utility companies quickly followed Olivetti into the market to lock in long-term funding at historically low costs. However, the glut of deals initially overburdened the market and the window for 30-year supply closed until later in the year.

Debt bankers believe the 30-year debt market is established and will continue to provide supply in 2004, although demand could diminish. However, 15-year debt, which has only been a feature of the European corporate market for two years, will continue to flourish.

Several companies tapped that part of the maturity curve in 2003, including BMW, the German carmaker, and RWE, the utility, which were both able to launch deals in just a few hours during summer. One banker said: "The development of the long-dated sector has been astounding and it is now possible to do a 30-year transaction in a day."

The European corporate bond market enjoyed a stellar year in 2003 as unprecedented demand, low interest rates and cheap borrowing costs boosted new issuance to unexpectedly high levels.

In a highly attractive credit environment that one debt banker called a "highway to success", new borrowers and innovative products entered the European debt market, helping it to mature.

The supply level in the European corporate bond sector cheered fixed-income bankers, who were left shell-shocked at the end of 2002 after the most hostile year for new issuance since the inception of the euro in 1999. Primary bond volumes soared as companies took advantage of huge demand to refinance outstanding debt and recapitalise their balance sheets by issuing a range of debt instruments.

Olivier Khayat, head of debt capital markets at SG, said: "Last year, the market plugged the gaps in terms of maturities, types of issuer and types of deal. It is now possible to price a deal for almost any company in any maturity."

Khayat said the trend of new borrowers entering the debt markets will continue in 2004 as companies take advantage of the attractive environment for credit. However, he added that while the number of transactions will increase, average deal size is likely to fall this year.

Credit analysts at ABN Amro believe that corporate bond supply in euros and sterling will fall by 25% to 30% in 2004 because borrowers have made progress in mending balance sheets and have been more restrained with capital expenditure and merger and acquisitions activity.

However, Martin Hibbert, a director of debt syndicate at Deutsche Bank in London, said the likely fall in new issuance is merely a correction. "Annual euro-denominated bond supply has been roughly [euro]130bn in recent years, but a favourable market and issuers looking to prefinance pushed the total to around [euro]160bn in 2003."

Another trend last year was the decline in jumbo bond supply as companies reined in debt issuance and focused on deleveraging to strengthen their financial profile and stave off negative credit ratings pressure.

There were a handful of exceptions to the trend of more, smaller deals in 2003, most notably the record-breaking $17bn equivalent bond from General Motors, the US auto company, in June (see Deal of the Year, page 54).

The deal, which was launched via most of the world's largest debt banks, surpassed the previous record held by France Telecom and proved it was possible to raise billions of dollars of debt despite market concerns over credit weakness.

The GM bond, which raised funds in the euro, sterling and dollar bond markets and included a convertible debt tranche, dispelled doubts about the company's ability to raise such a large amount of debt, attracting more than $30bn of demand. Its success opened possibilities for companies wishing to raise funds and it was hailed as a watershed.

The deal, which helped to plug a vast deficit in GM's pension fund, proposed a potential solution for others struggling to make up for shortfalls in their schemes that were unearthed following accounting rule changes and the bear market.

Bankers said more companies could turn to the bond market to reduce pension fund deficits in 2004, particularly in light of the trend towards a greater focus on liability management at companies. Liability management was one reason behind the spurt in corporate supply last year as companies replaced outstanding debt that was issued at a high funding cost, with fresh debt offering less yield because of low interest rates.

The attractiveness of issuing bonds, combined with investors' desperate hunt for instruments offering sufficiently high yield, helped to pave the way for a new fixed-income asset class - subordinated corporate debt.

Linde, the German gas and engineering company, saw strong demand from yield-hungry institutional investors and retail bond buyers when it launched the first undated subordinated corporate Eurobond in June. The [euro]300m deal, which was led by Citigroup and Deutsche Bank, attracted more than [euro]1.4bn and was increased to [euro]400m. It enabled the group to refinance senior debt and extend the duration of its debt to take advantage of low rates.

Five months later, Michelin followed Linde into the subordinated debt market, which until last year had been the preserve of financial institution issuers. The French tyre maker's 30-year bond, which was led by SG, was increased after being twice oversubscribed. Bankers who worked on the deal said it appealed to investors on the back of the extra yield available compared with tier one, or subordinated, debt from bank borrowers.

Linde and Michelin helped to set a precedent for the corporate subordinated bond market, and bankers expect further issuance as investors and borrowers become more familiar with that product.

For more information, please visit http://www.gale.com.

Copyright (c)2004 Financial News. All rights reserved. Copyright (c)2004 Gale Group. All rights reserved. Distributed by FluentMedia, a service of Tribune Media Services. Copyright (c)2004 by Tribune Media Services