EU corporate issuance is waning, says S&P

EU corporate issuance is waning, says S&P
Our Markets Bureau
24 June 2002
London: Issuance volumes in the European Union (EU) have been lacklustre so far this year, belying expectations that bond issuance would remain healthy in the first half of the year as long as interest rates were on hold, says Standard and Poors (S&P).

A reduced flow of refinancing activity related to mergers and acquisitions is partly responsible for the slowdown from the record levels recorded in the past two years.

In the period between 1 January-14 June 2002, total issuance of $308.8 billion was recorded, comprising 1,418 issues. Issuance volume is running 12.6 per cent below last years levels in the five months completed to date. However, the number of issues is running 22 per cent above the corresponding period a year earlier, suggesting that a number of small firms continued to come to market even as last years jumbo issuers, notably from the telecommunications and automobile sectors, curbed bond issuance.

"Notwithstanding the drop in volume, the increase in the number of issuers provides evidence of ongoing disintermediation and diversification in the European issuer base," says S&P head (global fixed income research) Diane Vazza.

The decline in issuance volume in the European Union (EU) no longer appears limited to the beleaguered telecommunications sector; however, the biggest declines are still among telecommunications issuers, where volumes have dropped 76 per cent compared with a year ago, says the study.

Other prominent issuers notably banks and industrials also recorded year-over-year declines in issuance volumes of 7 per cent and 13 per cent, respectively.

Non-banking financial institutions and utilities were the only sectors showing increases of 36 per cent and 54 per cent, respectively, albeit from a relatively low base of issuance. Increased volume of issuance by utilities was driven by a recent spate of merger-and-acquisition activity, whereas rising issuance among non-bank financial institutions was driven in part by buoyancy in consumer finance lending as well as in auto and equipment leasing.

By nation, the top issuers were Germany ($89.7 billion), the Netherlands ($46.1 billion), the United Kingdom ($45.2 billion), and France ($38.5 billion).

As was seen in the first quarter, higher-rated firms have been more successful at raising funds in the bond market. This is not surprising, given investor risk aversion and concerns about creditworthiness. It also attests to the fact that top-rated EU firms have been less affected by concerns about headline risk swirling around in the US. The volume floated by AAA-rated issuers as a share of total rated volume increased to 32 per cent in the first five months of 2002 compared with 29 per cent a year earlier.

Similarly, the proportion of issuers in the A range (i.e. A+, A, A-) dropped considerably to 29 per cent of total rated volume compared with 43.5 per cent a year earlier.

The increased migration of issuers from the A range to the AA range this year reflects increased issuance by banks and utility companies rated in the AA range this year, which supplanted issuance by manufacturing and telecommunications issuers rated in the A range in the corresponding period a year earlier, says S&P.

Meanwhile, the yield spread between longer-dated and shorter-dated bonds remains constrained, reflecting moderate inflation expectations. The yield spread between 10-year swaps and the one-year swap had narrowed to 132 basis points on 13 June compared with 183 basis points at the start of the year.

Nonetheless, European firms have not responded with much gusto to the moderate interest-rate environment.

"There has been opportunistic issuance by some firms, but many others are remaining on the sidelines until earnings and profitability pick up materially. Fundamental indicators such as capacity utilisation, industrial confidence and new orders have started to show uplifting signs compared with the early part of the year, but still remain well below levels associated with healthier profitability," says Vazza.

According to S&P the prospects for the remainder of the year look downbeat. The European Central Bank is expected to raise interest rates in the second half of the year, thereby narrowing the window of opportunity firms have had for opportunistic issuance.

A convincing recovery in capital spending could partially compensate for this dampening effect, but has yet to materialise in tangible terms as seen in the negative trend in the EU quarterly fixed capital formation that has been in place since the third quarter of 2001.

The risk of higher oil prices as well as concerns about pay increases outstripping labour productivity could tarnish expectations for an impending recovery in business investment. Moreover, the high level of ratings downgrades suggests that a number of European corporations have already borrowed in excess of optimal levels and are therefore apt to have reduced appetite for further borrowing in the months ahead.