Rumours of the demise of the euro-denominated 30-year corporate bond market are much exaggerated. True, primary as well as secondary market activity has probably failed to live up to the expectations of the most enthusiastic evangelists of long-dated corporate issuance in euros. That enthusiasm appeared to be warranted during the first six weeks of 2003, when six new issues were launched (seven, if you include an increase to an existing deal from Olivetti), raising €4.35 billion, with France Télécom’s €1 billion benchmark 2033 issue the highlight in terms of size and liquidity.
But this flurry hardly opened the floodgates for long-dated euro issuance, with only three deals launched since then. Most notable among those was the €1.5 billion 30-year euro component of General Motors’ mammoth multi-tranche pension deficit-plugging issue, which chalked up a new record as the largest long-dated corporate deal in euros.
Although Peugeot and Veolia Environnement both added to the list, by the end of the year the universe of credits that had raised long-dated euros remained tiny. By December, there were €12.6 billion of corporate bonds with maturities of longer than 15 years in the iBoxx index, compared with almost €360 billion of sovereign paper with the same maturity profile. As a percentage of the European corporate bond universe, bonds with 15-year maturities or longer (with a size of €500m or more) accounted for 2.23% of the €562.7 billion total market.
There are a number of good reasons explaining why 30-year corporate issuance volumes have remained muted in euros. Above all, says François Bleines, head of European corporate syndicate at Deutsche Bank in London, in the absence of a well-developed pension fund industry in most of continental Europe, there is a limited group of natural takers of longer-dated credit.
Even some of the more natural takers of longer-dated issuance have had problems assessing value in a market that has been in existence for less than 18 months. “Our view is that investors initially found it hard to price long-dated paper,” says one London-based investment banker. “For example, in the case of the RWE deal the bonds tightened by 10bp in the immediate aftermarket, but then widened out by 30bp from the initial spread launch. That prompted some concerns about whether the 30-year paper was being priced correctly or just attracting hot money that was coming in and taking a quick profit.”
That is perhaps an inevitable teething problem associated with the launch of a new market at an unfamiliar point in the yield curve. But for the time being, the principal barrier to the rapid expansion of the 30-year market in euros appears to be a dearth of supply.
For bankers pitching 30-year bonds to their European clients, the corporate universe likely to tap the euro-denominated market at the moment constitutes only two types of issuer. Those companies with a very obvious need for longer-dated funding, many of which were active issuers in the long-dated sterling market prior to the launch of the euro, such as EdF and RFF of France. Although these borrowers, most of which are in the utility and transportation sectors, can be expected to continue to tap long-dated markets in sterling and – where possible – euros, they constitute a finite and limited borrower base.
The second group, which has become increasingly sparse in recent months, is made up of those companies with no obvious need for longer-dated funds but with a borrowing requirement so large that they need to tap into every possible investor base. The most obvious example of this is GM. In order to raise $19 billion in one multi-tranche exercise last year, it needed to raise dollars, euros and sterling across the entire maturity spectrum.
In the US market there is a third group of borrowers which also rely on long-dated borrowing; industrial companies that do not need long-term funding, have modest overall borrowing requirements but are opportunistic. Bleines at Deutsche Bank points out that for the most part European companies are quite different from their US counterparts, which are often comfortable with raising opportunistic long-dated funding and taking interest rate exposure.
Although that may make the potential for 30-year bond issues look depressingly weak, bankers remain upbeat about the longer-term prospects for the sector. Above all, they argue that the market will be driven by increasingly robust institutional demand for long-term assets.
That was certainly the conclusion reached by a study published last December by ABN Amro, which analysed the pressures on Dutch pension funds of close duration mismatches and the implications of pension reform elsewhere in core Europe. The ABN report calculated that new money being channelled into French pension-related insurance schemes over the coming few years will be in the order of €8–10 billion annually. In Germany, meanwhile, the research reckons that by 2008 the pension market should be worth some €129 billion. The ABN conclusion was that “both the French and German reforms strengthen the case for richer long-end rates”.
In the short term, the principal beneficiaries of increased institutional demand for longer-dated bonds will be government borrowers and other triple-A rated issuers in the Eurozone, and sovereigns are clearly supporting the growth of the 30-year maturity.
In its forecasts for borrowing patterns in 2004, Commerzbank Securities calculated that European governments will raise €37 billion in the 30-year maturity this year, with Italy accounting for €14 billion and France, Germany, Spain and Belgium contributing the rest. As this process gathers momentum it should lead to a progressive compression of the spread between 10-year and 30-year euro paper. Institutional demand and the pursuit of higher yields should encourage more lower-rated borrowers to tap the longer end of the market.
Bankers insist that the foundations upon which this market will be built have already been laid. “A clear market sector has now been established with enough benchmark bonds to allow investors to make meaningful value comparisons,” says Andreas Schlotter, head of European corporate debt origination at UBS in London.
Bankers believe that more benchmark issuance will breed confidence in the pricing of 30-year transactions. And increased primary market issuance will inevitably beget more liquidity in the secondary market. Until now 30-year credit has been bought chiefly by buy-and-hold insurance companies and pension funds. But that is not to say that long-dated corporate bonds have been entirely illiquid, with hedge funds having become increasingly active. In 2003, that was especially noticeable in a handful of the 30-year telecom and utility bonds.
Schlotter at UBS says that in the case of the telecom and utility sectors, the volume of trading activity by so-called leverage buyers has now diminished, with the deleveraging and spread tightening story having probably run its course. Most 30-year bonds from telecom and utility issuers are now tightly held by long-term institutions. Bankers say, however, that the one euro-denominated 30-year corporate bond that continues to be very actively traded is the GM 2033 issue.
“The nature of the auto industry combined with the size of the bond allows investors to trade in and out of the GM issue, which is very actively traded by the more trading-oriented accounts,” says Schlotter.
While more liquidity across a broader selection of longer-dated issues would clearly help the development of the 30-year market in euros, the general consensus among bankers is that a more active market will develop at the long end of the curve. For the time being, however, they say that the market is suffering from the same supply starvation that is hitting the whole corporate bond market.
“I think we will see more supply in the sector when broader issuance starts to rise on the back of rising capex and more M&A refinancing,” says Schlotter. “But it is hard for any sector to develop while the market remains so under-supplied.”