Snuff, puff and paper go to euroland
Salomon Smith Barney managing director Eirik Winter, head of the bank's Nordic capital markets desk, has every reason to be pleased. In mid-September his team held three out of four Eurobond mandates for Scandinavian corporates then preparing to come to the markets. A year ago, this level of Scandinavian activity would have been hard to imagine.
Overall, 1999 has been an exceptional year for European corporate Eurobond issuance and Scandinavia has been no exception.
A heady mix of rising merger & acquisition activity and the creation of a single-currency investor base at a time when loan margins are rising has challenged many of the region's corporates to find alternative methods of funding and many have chosen to issue Eurobonds for the first time. European investors' increasing appetite for corporate credit and the creation of a real credit market in Europe is radically changing the way the region's corporate treasurers borrow money.
"There has been a dramatic change," says Winter. "Everyone had been hoping that a US-style capital market would come to Europe with the single currency. But we've been surprised at just how fast this has exploded."
Since Scandinavia's first corporate euro Eurobond at the turn of last year - a landmark seven-year €200 million ($212 million) deal put together by Salomon for Finnish paper company Metsa-Serla - there has been a steady stream of Nordic corporate Eurobonds.
The success of the Metsa-Serla deal proved that there was an alternative to bank finance and that lower-rated corporates are now welcome names in the Eurobond market.
This year's Scandinavian bond issuers have included Ericsson, ABB, Investor, Telenor, Vattenfall, TeleDanmark, AssiDomän and Sonera. Some of these borrowers, for example Vattenfall, are becoming frequent issuers.
"At the time of the Metsa-Serla deal, a lot of people were sceptical," says Winter. "They said that the company was coming too early, that the market was not ready for triple Bs, particularly from a difficult sector like forestry. I'm the first to admit that it was a challenge, but at the same time we had to weigh this against the fact that if we had waited until January or February, we knew that there would be a pipeline building and it would be hard to get the focus from investors."
The strategy paid off and Salomon considers the deal a huge success. "We went for 120bp over the seven-year Bund and the deal traded in very quickly to around 100bp over. It has performed extremely well."
Winter draws a comparison with subsequent Eurobond issues from better-rated credits that have not performed as well as the Metsa-Serla issue. He says: "We got a lot of focus because we were the first out into the market. Some other deals have been a little less lucky with their timing. There have been a lot of competing roadshows out there and with relatively small issues it is always hard to get investors' attention. Some [Scandinavian deals] have not received the recognition they deserve from the market."
But there have also been critics of the high price paid even for more successful Eurobond deals. When the Metsa-Serla issue came to the market, competitors were quick to accuse Salomon of creating an unpopular price level and distorting the market for better-rated issuers. They pointed to similar Scandinavian deals in the syndicated loan market coming in at just 20 basis points over Libor.
However, with the increasing scarcity of banks willing to make loans at rock-bottom prices, Scandinavian corporates are more and more forced to pay the price and issue Eurobonds. Says Winter: "Metsa took a strategic view that it wanted to access sources of funding other than the bank market and it has paid off for them."
So far, most Scandinavian deals have been modest in size by the standards of a European corporate bond market that has grown used to e1 billion issues. But bankers expect deal sizes to increase soon.
The €1 billion mark has already been surpassed with Ericsson's Eurobond brought by Salomon and ABN Amro in June. The two-tranche deal - a €650 million five-year tranche and a $500 million 10-year tranche - easily raised more than €1 billion.
Other billion euro plus deals are set to follow. On September 17, Volvo announced a €1 billion five year Eurobond in the wake of its bid to take over truck maker Scania. The A3/A-2 rated borrower is coming to market to help finance the merger of its own truck division with truck maker Scania following the sale of its car business to Ford. Norsk Hydro also announced that it would issue a large, longer-term inaugural Eurobond issue at the beginning of this month via ABN Amro.
Two billion and beyond
Many bankers think that such names as Volvo and Ericsson could now launch deals of up to €2 billion and perhaps beyond. Says Thor Askeland, head of the Nordic desk at Lehman Brothers in London: "There are quite a few Scandinavian corporates that have the balance sheet to do billion plus deals."
Before details of the Volvo Eurobond were confirmed, there had been speculation that the final deal size could top €2 billion, surpassing the Ericsson deal as the largest Scandinavian corporate Eurobond to date.
As the region's borrowers gain more recognition in the Eurobond market, bankers note a change in attitude on behalf of their clients. Says one: "In previous years we would have gone to corporates and suggested this or that deal and they would have said: 'Why would we want to do a bond deal when we can get cheaper bank credit?' But this year the reaction has been much more positive. Treasurers and chief financial officers want us to come and talk to them and they want to hear what is happening in the market. They have Reuters screens and are beginning to follow what's going on in the markets. After you do a deal and call them up to tell them about it, now they say: 'Yes, we saw that, congratulations.' Two years ago they would say: 'That is great, but what has it got to do with us?'"
Ericsson treasurer Vidar Mohammar says this growing interest in the capital markets may spring from corporate treasurers' fears that the capacity of the senior bank loan market to fund them may drastically decline. He says: "From our point of view, going to the public markets is better because we aren't risking availability [of credit] with just one bank. We will still use the bank market for short-term facilities and liquidity management, but Scandinavian corporates will now become much more focused on capital markets."
Behind this change lies the commonly heard story that the single currency has powered Europe's much-vaunted corporate debt market. Before the single currency, it was fragmented and dominated by local investors reluctant to buy paper denominated in European currencies other than their own.
But with the advent of the euro, treasurers have suddenly found a much wider universe of potential investors, enabling them to raise money at historically low yields in the euro Eurobond sector. They have also lost their cozy relationship with domestic investors which are now seeking diversification and higher yields.
Justin May, director of global fixed-income origination at ABN Amro - which along with Salomon Smith Barney has dominated Scandinavian corporate bond issuance this year - has spent much of 1999 speaking at capital markets seminars for corporates across Scandinavian countries on the development of the corporate Eurobond market.
May thinks that the arrival of the single currency has been a large factor in attracting Nordic corporates to Eurobonds. He says: "The euro has allowed investors to invest across Europe without the former restrictions placed on them by currency. EMU created an environment where it is possible for Nordic corporate issuers to tap the Eurobond market rather than having to rely on the bank market or the yankee market to raise funding."
Since the euro's launch, it has been a clear favourite for Scandinavian borrowers, whether in the single currency zone or not. So far this year, 63% of all Nordic issues have been euro-denominated, compared with 25% in dollars, 5% in sterling and the rest in other currencies.
Euro issuance is rising fast. In the first six months of 1999, euro issuance by Nordic corporates and utilities leapt to 18 issues totaling €3.69 billion compared with just six in participating currencies worth €883 in 1998.
"It is now getting harder to place US dollar-denominated paper in Europe," says Lehman's Askeland. "Before the euro, there was a large US dollar buyer base of European investors that would buy and hold dollars when they were not buying issues denominated in their home currency. These investors are now focusing on the euro and have for the moment lost their interest in dollars."
Although a weak euro has not favoured borrowers issuing in euros and swapping back into domestic currencies, it hasn't deterred them. Many Nordic corporates from outside the euro bloc, such as Norway's Statoil and Sweden's AssiDomän, have kept liabilities in euros in order to finance growing cross-border operations. Borrowers that swapped euro proceeds back into domestic currencies are finding that the swap markets are liquid.
Ericsson treasurer Vidar Mohammar says that the euro has quickly become a viable and liquid market for corporate borrowers. "This has happened much faster than we expected and will affect the way [Scandinavian corporates] borrow," he says.
Freeing the hostages
Joe Dryer, global head of debt capital markets at Paribas - a big underwriter of euro-denominated Eurobonds - says that the development of the market has surprised a lot of people: "Europe is rapidly moving towards a credit market with a single homogenous investor base that is eager to purchase corporate paper. We've seen pension funds that were once restricted strictly to triple A deals that can now buy down to A- across Europe.
"For the first time Scandinavian borrowers have had an alternative to bank loans and the yankee market. Until recently investors have been held hostage in their own markets. But we have seen the creation of a market with a single investor base that will rival the US bond market."
Although Scandinavian borrowers still pay more in the Eurobond market than they have traditionally done in the local bank market or syndicated loan market, the gap is narrowing.
Large Scandinavian corporates could traditionally obtain five-year bank loans at less than 20bp over Libor. But in the past year spreads have been rising to 40bp over Libor and borrowers say the bank market is becoming steadily less liquid. As banks become increasingly shareholder-conscious, the business of low-margin lending has been radically cut back. Banks have become much more careful in how they allocate their capital - lending money at negative or just positive return on equity is becoming a thing of the past. And bank mergers and other cost-saving exercises have also reduced the supply of cheap credit available to Scandinavian corporates.
Says Winter: "A lot of the big lenders, people like UBS and JP Morgan, have all but withdrawn from the lending business. The Japanese have been gone a long time, there are still some Landesbanks lending money, but after that it comes down to domestic banks that have also realized that you can't get returns of 15% to 20% by making loans at under 30bp over Libor. To do this they would have to be making loans at 150bp."
Corporate treasurers would love to keep taking cheap money from banks, but they see the general trends. Says Heikki Saarinen, managing director of Metsa-Finance: "We wanted to be less dependent on the bank market. The market is becoming more like the US. In the future, the Eurobond market will become our primary focus, although of course we will still use bank financing."
For many of the region's corporate borrowers, the creation of a credit market on their doorstep has been one of the most exciting developments in recent years. Scandinavian borrowers have decided that it is worth paying 100bp to 120bp over Bunds to promote themselves internationally and free up short-term credit lines by lengthening the maturity of their debt portfolio.
Scandinavia's triple B companies can now raise 10-year money from the Eurobond markets. Marianne Okland, who heads JP Morgan's Nordic team, says that Scandinavian corporates are getting better deals in the euro market than in the US yankee market, which was, until a year ago, the only source of long-dated capital markets funding for many Scandinavian corporates. "Fees are lower and corporates are generally getting a better price in Europe," she says. "This year, European deals have been an average 15bp to 20bp cheaper than similar Yankee deals."
In Europe, lower inflation, reduced government bond issuance and the disappearance of currency risk have left investors searching for yield. ABN Amro's May explains: "Investors used to make their money by playing government bond spreads and currency movements. But with the single euro domestic market and a low interest rate environment in Europe, European investors can no longer make money just by investing in government bonds. So what are their options? They can either move down the credit curve and or move out along the maturity curve."
Something like 50% of European institutional investors have already built dedicated credit research teams and the balance want to develop this capacity in the near future. European investors' increasing ability to analyze corporate credit has opened the market to lower-rated Scandinavian borrowers.
An additional force driving increasing Scandinavian corporate issuance is the fact that Europe is rapidly becoming a corporate battleground for mergers & acquisitions. Says May: "Much of the corporate issuance has been driven by M&A activity and the refinancing of short-term debt with longer-dated debt to free up committed lines."
In the brave new world of the euro, many Scandinavian companies are coming to the market even before they have found target companies so they can be ready to make a bid or defend themselves from an unwanted takeover. To do this they are building war chests and freeing up credit lines, many by issuing Eurobonds.
Most major Scandinavian corporates now have MTN programmes. Many of this year's deals, including those by AssiDomän, Swedish Match and UPM Kymmene, have been inaugural Eurobonds off the back of MTN programmes and many plan follow-up deals in the private-placement market.
Ericsson's MTN programme gave it the flexibility needed to manage its large-scale customer financing operations and acquisitions. "So far we have raised nearly e2 billion from it," says Mohammar.
Beware gold-rush hustlers
But for many Scandinavian corporates, the Eurobond markets remain unfamiliar territory. And with the increasing pace of the bond markets, bankers are urging caution for first-time issuers. Dryer's advice is not to rush to market too soon. "In any market scramble where you have a gold-rush mentality, you get a lot of hustling. Our advice is to choose your lead managers carefully and focus on a well-prepared transaction."
Some banks have been playing on fears that the millennium bug will cause the bond markets to overheat in the run-up to New Year. With the possibility of a market bottleneck, bankers say it could be only a matter of time before a Scandinavian corporate brings an ill-prepared transaction to the market.
Investors have long memories, particularly for debut deals. Says Dryer: "The market can show very little mercy. Because there are so many deals coming to the market, buyers can pick and choose. So yes, the market is there, but preparation is the key to ensuring issuers will have a warm welcome back."