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| Russell Maybury Managing Director, Head of Corporate DCM - UK & Ireland, RBS |
Diversification has become the watchword for corporate treasurers seeking reliable access to funding. They are looking to multiple sources, a broad investor base, bonds of different maturities and in different currencies.
The situation has been thrust upon them to some extent. Banks continue to lend, but their higher regulatory burden and scarcity of capital post crisis means loans that were once virtually free are now precious and strategic. The days when large banks could hold big debt positions in companies appear numbered.
Even if corporates currently meet their funding needs through banks, the lesson is to diversify in good times and avoid reliance on one form of liquidity when a major shock hits – a so-called ‘Black Swan’ event.
The challenge is to achieve the right mix of funding and to recognise the opportunity cost of that particular strategy. Banks with balance sheet to deploy are still an important part of the mix but how should corporates use them while also taking advantage of the boom in capital markets?
Capital markets on the march
Increased issuance via capital markets is the most obvious example of how European companies are changing their borrowing strategy. Capital markets have long provided the lion’s share of money to US corporates, but the rise in Europe has been rapid in the last five years. By 2011, it accounted for two thirds of big cap funding and over half of mid cap borrowings – up from just 19 per cent in 2008.
Yield-hungry investors are pouring in. They understand the corporate credit story better now than two or three years back and as a result are more comfortable putting more money to work in not only conventional corporates but relatively new sectors such as housing associations, universities and local authorities.
The sums invested are increasing too. A top UK pension fund for example might now be able to invest GBP200-300 million in a benchmark bond where it typically allocated GBP100 million three years ago. Small stockbrokers that provided under GBP1 million before are typically now happy to put in GBP2 to 3 million. The number of investing institutions capable of investing GBP50 million or more has significantly grown too. The market is no longer dependent on a handful of investors. Deals can still be done without the usual suspects weighing in.
As for the issuers, capital markets are no longer the preserve of the big boys alone. A-grade multinationals are continuing to issue but they have been joined by lower-rated names as investors hunt for yield. BBB-grade companies more than doubled their share of market issuance between 2008 and 2012 – up to 34 per cent. And BB and unrated companies, for whom the market would have been closed five years ago, last year held a 13 per cent slice of the European market.
Even if a mid-cap corporate only wants GBP50-75 million it is increasingly able to find funding through a private placement.
Hybrid bonds play into this diversification story. A third of corporate bonds on the sterling market were hybrid in the first quarter, compared to 19 per cent a year earlier. Why? Because investors who understand credit are happy to go down the subordination route. Despite their higher coupon versus senior debt, hybrids are tax deductible and therefore a cheaper option than equity issues. In strengthening the balance sheet, diversifying funding and supporting the credit rating, hybrids are becoming an increasingly important piece of the funding strategy, both for rated and unrated companies.
Investors are becoming a lot more comfortable with hybrids too. Mid-cap names that would have struggled to successfully issue a couple of years ago can now access the market.
These deals are not only diversifying funding channels and balancing debt across both secured and subordinated markets, but also unlocking money that would not otherwise have been provided via bank lending. This new source of funding is supporting future growth rather than simply refinancing existing debt.
Changes in the funding landscape are also shaking up relations within companies. As firms wrestle with more complex financing questions, treasurers are becoming a more important strategic player within the business. The boardroom is starting to recognise that though it may set the company’s broad direction, issues around funding that sit with Treasury, such as liquidity, credit ratings or longer term funding, today have far more potential to hurt the firm’s prospects.
Treasurers’ growing profile may help explain why companies are getting better at communicating with debt investors. Listed companies’ natural focus on the share price means many have traditionally prioritised equity investors. But close connection between treasurers and the debt community has helped firms see the advantages of spending as much time keeping bond investors up to date. Such a policy will pay dividends when new money is needed. After all, regular bond issuance is a normal corporate activity; a rights issue on the other hand is more like an ejector seat – it will save you, but you can only use it once.
During the events of the past few years, corporates saw their banking counterparties in crisis, their own credit spreads widen to astronomical levels and auditors and rating agencies bearing down on them. It has been a salutary experience. More diversified funding and clear communication can help them avoid a repeat.
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