In 2008 conditions were perfect for convertibles and issuance disappointed. In the second half of the year volumes collapsed and just 32 deals were completed. In 2009 leverage remains an issue for many companies, yet terming out debt, and the ability to access markets, have been just as important. This has ensured a recovery in US and European CB markets, as Owen Wild reports.
The structured equity market divided down geographical lines in 2009. The start of the year saw more rearrangement in the ranking of banks in Europe. The once dominant forces of Deutsche Bank and JP Morgan have played bit part roles in 2009 – despite JPM's 25% market share in straight equity.
It is Morgan Stanley that now sits pretty at the head of the top table. It did the most deals and won greatest bookrunning credit. In the months of inactivity some banks cut equity-linked staff; others persevered in pitching, but struggled to even secure meetings with CEOs. Morgan Stanley switched its two originators into other related roles.
As an ECM originator it was suddenly possible to secure meetings to talk with CEOs and CFOs about their finances. While there, convertibles could be introduced as one of a selection of potential avenues. Once the market was open, Morgan Stanley followed up those earlier conversations.
The switch to outright accounts has particularly suited the French banks, ranking second, third and fourth. French corporates have often used convertibles, while France has always been home to a large pool of outright buyers. The two have combined to produce much of the issuance in 2009 - and the CAC40 has yet to be exhausted.
In Asia, companies entered the year with pretty highly-leveraged balance sheets, steering them away from convertibles altogether, and into equity. Mandatory convertibles were not seen as an option: there were few obvious buyers and alternative structures prompted confusion on the part of issuers - are they debt or are they equity? An overnight equity deal was often the solution, resulting in just seven CB deals in the first half.
In Japan issuance was zero. The standard issuing structure is price bonds at 102.5 and offer zero coupon, presenting investors with a negative yield. This worked when the market was dominated by hedge funds able to extract value from the equity. But now that bonds are an outright play, no yield means no buyers.
Fair comparisons of activity in the US for H1 2009 relative to the same period in 2008 is difficult because last year the market was so dominated by FIG issuance. Volume in H1 2008 was US$52bn, while this year it stands at just under US$16bn. The drop reflects the switch by banks from issuing hybrid securities in 2008 to having to issue straight equity in 2009.
While total volume is massively down, deal flow has remained strong. The US market opened in January with Newmont Mining, setting the pattern for what would follow as the company completed concurrent equity and equity-linked issues. The issue of equity was seen as a way of making the overall size of the fundraising more digestible, leading to cross-pollination of both books. It is no coincidence that the US league table at the end of the first half was topped by the two bookrunners on Newmont: JP Morgan and Citicorp.
While companies in Asia were not keen to take on additional debt in the US and Europe, the convert market was frequently used to term out debt. Some firms issued paper even though their next repayment debt was not until 2012. The important factor was to show access to the market. As such, some companies saw their stock rise on the day of issue. The removal of one of the inevitable downsides of CBs - a stock price hit by delta hedging and dilution fears - helped attract more issuers to market.
Capacity has been a concern throughout the year, despite huge levels of oversubscription on early issues. The largest deal seen in the US market in H1 was US$862.5m for US Steel. In all 21 deals have come at a modest US$50m–$200m.
The European market therefore saw more issuance than the US in Q2, despite the US being comfortably larger for the previous nine quarters. In Q2 the US market saw 43 deals totalling US$12.3bn. Europe saw 22 new bonds with total proceeds of US$12.5bn.
It was only in the last week of Q1 that the European market woke from its eight-month slumber with the first issue by ArcelorMittal. As in the early days of the US market, deals came cheap to ensure interest. Yet bankers were astonished to find that despite the collapse of many arbitrage funds – once the core of demand – orders were large and plentiful. The first deals were often 10 times subscribed.
The success of the corporate debt market had stifled CB issuance earlier in the year, yet that now provided a benefit: fixed income accounts struggling for allocations began to participate in converts as well.
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