Treasury Today Country Profiles in association with Citi

Time to exercise some liability management?

European corporates are being presented with an opportunity. Low interest rates, strong investor demand and robust cash balances have combined to create an environment conducive towards debt reduction, or ‘liability management exercises’ as they are often known in the banking sector. But how long will such an opening last?

In recent months businesses have taken to paying down a portion of their debt early by means of issuing new corporate debt at cheaper rates. “If you have a bond maturing in the near term, the current market is ideal if you want to extend the maturity or achieve a lower coupon,” says Vinod Parmar, Group Treasurer of Ladbrokes, a leading betting and gaming company.

Investors are lapping up high-grade paper and bonds as they seek safety from sovereign debts. For instance, in the first quarter of 2012 European corporate debt issuance increased by 83% compared to the same period a year previously. As the capital market becomes more crowded, bond yields are pushed down.

Rock bottom interest rates are also playing an important role. By serving as a benchmark by which corporate debt is priced against, absolute funding costs for businesses have declined. Some corporates are taking advantage of this opportunity. According to Barclays, non-financial companies launched offers to buy back nearly €14 billion of bonds since January. Investors have accepted over €5 billion worth of these tenders.

The energy company Iberdrola is a good example. The Spanish corporate recently launched a €1 billion eurobond, with a coupon of 4.25%, which matures in 2018. Issue proceeds went towards buying back €900m worth of two other bonds due to mature in 2013 and 2014. The key difference being that these bonds were more expensive to uphold, with coupons of 5.12% and 4.87% respectively. Atlantia and Roche are other examples of European corporates taking to bond buybacks; the former launching a seven-year bond in February to finance the buyback of €750m of its 2014 notes.

High-grade corporate debt is sought for a number of reasons. Predictability and transparency are foremost among them. Since the onset of the Eurozone crisis, corporates have become far easier to analyse and evaluate compared to sovereigns. Another factor is the €1 trillion that is flowing through the European banking system as a result of the European Central Bank’s two LTRO operations (Europe’s answer to quantitative easing). Inevitably, such an enormous sum of money will splash upon the shores of the capital markets as investors seek out safer returns.

But of course, there is no free lunch. When launching debt tender offers, corporates often face a trade-off. There may well be a premium to pay as investors will want to be compensated:

“If your original bond had a 7% coupon when you issued it, but your new issue achieves a 5% coupon, this means that it is quite likely your bond is trading above par. After all, interest rates are dropping,” says Parmar. “So you will have to pay up. You won’t pay 100 for a bond; instead you may have to pay 104. There is an upfront hit in buying back.”

Non-financial corporates are not alone when it comes to liability management exercises however. European banks have also been taking advantage of the European Central Bank’s LTRO to pay down existing debt obligations. And they are doing so in defiance of the LTRO’s original objective: to boost lending to businesses so as to revive the wider economy.

All this means that European corporates are taking advantage of a situation that may not last; for Europe’s economic fundamentals rest on shaky foundations.

Reader Comments 

Please login or register to submit your own comment