IFR-Non-core corporate bond debate

(The following story appeared in the December 11 issue of
the International Financing Review, a Thomson Reuters
publication)

By Andrew Perrin

LONDON, Dec 13 (IFR) – The latest bout of eurozone sovereign
debt-fuelled volatility has led to the widening of non-core
eurozone corporate bond spreads, raising fears that the crisis
has curtailed these entities’ access to international capital
markets.

This has also triggered a debate as to whether these
valuations are actually a fair reflection of fundamental credit
risk, particularly with regard to the more international
companies that generate much of their revenues abroad.

Bankers argue that less volatile and better-rated frequent
corporate issuers should be able to do deals when the bond
market is open, at the right price.

But the recent surge in peripheral eurozone sovereign debt
yields has led to an unusual situation, in which many corporate
bonds are yielding less than their sovereigns, sparking the
belief that this is not an accurate indication of the credit
risk attached to those issuers.

European credit investors have balked in the past at buying
a corporate bond at lower yields than the company’s government’s
bonds. That was indeed the case until a few weeks ago, when ENI,
an Aa3/A+ rated Italian energy company that generated less than
one-third of its revenues domestically in 2009, managed to take
out EUR 1bn of seven-year money at about 15bp less than the
equivalent BTP.

However, hopes that this is the start of a more pragmatic
approach by investors should be tempered by the thought that ENI
might be a special case because it operates in the global energy
sector, where investors are more likely to look at international
peers, and by the fact that the crisis has not hit Italy as
badly as it has affected Ireland, Portugal and Spain.

“While there are good reasons for a multinational corporate
bond to trade through the respective sovereign, the evolution
and assessment of sovereign risk will remain one of the key
drivers of spreads for corporate bonds from peripheral countries
and credit markets in general,” said Markus Wiedemann, senior
fund manager for corporates at DWS Investments.

He highlighted Spanish telecoms giant Telefonica, which
earns more than 60% of its revenues outside Spain, has stable
Baa1/A- ratings and a solid footprint in Latin America.

“This is a strong company with a positive credit story and
there is no reason why it should not trade through Spanish
government bonds,” Wiedemann said, adding that he would be
prepared to add corporate risk at tighter levels than the
sovereign.

As it happens, when Telefonica reopened the investment-grade
Spanish corporate market in September after a six-month hiatus,
it raised EUR1bn of seven-year funding at mid-swaps plus 148bp,
approximately flat to the Double A rated government yield curve.
It now trades around 35bp through Bonos.

James Briggs, a credit portfolio manager at Henderson Global
Investors, argues that this phenomenon should really be limited
to multinational companies such as Nestle and Unilever, which
have the true global diversification that would allow them to
move their operations to a different geographical location if
necessary.

“There are very few companies in Euroland that meet this
criterion, with the vast majority stuck in a specific location,
either by virtue of their asset base or due to national
regulation,” Briggs said.

Building materials producer CRH, rated Baa1/BBB+/BBB, is one
company to which this is applicable. Despite operating in a
challenging if not distressed field, it issued a dual-tranche
US$750m five-year and 10-year deal at Treasuries plus 270bp and
295bp, respectively. While the group is domiciled in Ireland,
only a small percentage of its revenues are derived there.

Emerging markets lessons

Investors in the emerging markets – Latin America for
example – have long been used to such volatility and situations
where a stronger international company’s credit risk diverges
from the sovereign.

“However, what we have seen in Europe until very recently is
that whenever there is a peripheral sovereign crisis it triggers
risk-aversion across the region and this contagion sees all
regional assets get hit,” said Ed Farley, portfolio manager,
head of European investment grade at Pramerica.

Henderson’s Briggs noted that early on in the emerging
market crisis the popular view was that there was a rational
case for the stronger international companies in the region to
trade at more expensive levels than the sovereign.

“However, what we actually saw as the crisis unfolded was
that these companies eventually get repriced in line with their
sovereigns. While the eurozone is clearly a different animal and
that’s not to say that this will necessarily happen here,
history shows us that it’s certainly a possibility,” he said.

So, even if there are examples of some investors accepting
the argument for some corporates to trade through the sovereign
curve, actually persuading them to add corporate risk at tighter
levels than the sovereign in the new-issue market is not going
to be straightforward.

Companies could be forced to provide an eye-catching spread
way above their secondary market levels in order to secure
sufficient traction, a scenario that would be difficult to
stomach for many, especially with the availability of bank
funding.

EDP (EDP.LS: ) signed a EUR2bn five-year revolving credit
facility at a margin of 95bp over Euribor less than a month ago,
“which is significantly more attractive when compared with the
utility’s outstanding euro bond curve, which is quoted closer to
300bp over”, said Noelle Cajigas, head of DCM for Iberia at BNP
Paribas.

As it happens, among the large Portuguese corporates only
EDP has a benchmark bond redeeming next year, in the shape of a
EUR747m 5.875% issue that matures in March.

It could be some time before this is tested, however, with a
number of factors combining to keep peripheral corporate funding
requirements limited next year. First and foremost, while
obviously differing from company to company, bond redemptions
are generally low in 2011 by historical standards.

The five largest issuers from Spain – Telefonica (TEF.MC: ),
Iberdrola (IBE.MC: ), Repsol (REP.MC: ), Abertis (ABE.MC: ) and Red
Electrica de Espana (REE.MC: ) – face combined bond redemptions of
a little over EUR5bn in 2011, compared with EUR8.8bn this year.

BNP Paribas’s Cajigas added that with the general lack of
growth in the economy as a whole, most companies did not expect
to have major financing needs anyway, as these predominantly
stemmed from funding requirements rather than any desire to
support significant capex or M&A activities.

Andrew Perrin is an IFR reporter)

[email protected]

IFR-Non-core corporate bond debate