Last August, Vodafone locked in record low borrowing costs for decades to come in two back-to-back sterling bond issues totalling £1.8bn. The celebrated borrowing made tapping the capital markets look an attractive option for treasury teams pondering how best to raise capital in the year ahead. “We do the vast majority of our borrowing in the bond market because we can get cheap, long-term finance,” says Neil Garrod, Director of Treasury, Vodafone.

Over the past 20 years, different borrowing options have fallen in and out of favour. In the mid-90s it was banks, more than the capital markets, where UK housing associations went to borrow money, recalls Fenella Edge, Group Treasurer at The Housing Finance Corporation (THFC), which borrows from the capital markets and on-lends to UK housing associations.

“Bank lending was used to fill much of the borrowing needs of our sector. Back then the bond market lost popularity because banks offered more flexible terms and bond markets were viewed as expensive – our 11.5% bonds have just matured,” she says in reference to a batch of mature THFC bonds which had yields at levels hard to imagine in today’s low interest rate world.

Now it is a different story. The pendulum has swung in favour of the bond market as banks remain reluctant to lend long-term, while borrowing costs in the capital market remain at historic lows. For corporates ready to take the plunge and swap cosy banking relationships for refinancing risk and a global investor base, today’s climate couldn’t be better. It’s an arduous process, but the benefits can be worth it.

Getting started

A corporation seeking to raise funds from a bond issue needs to tailor the offering to suit its own requirements, and ensure it is attractive enough to draw investors. A US private placement is a typical first step for a company expanding beyond bank finance for the first time. Available to both US and non-US companies, this market provides an alternative source of liquidity to the traditional bank market without the need for a credit rating or reporting requirements, which are generally needed in the public bond markets. The fact that public markets can close also makes public issues a more challenging debut.

The private US market comprises about 50 active investors, mostly US insurance companies, and is flexible. Issues range in size from less than US$100m to up to US$1bn; the market typically provides fixed rate US dollar debt in tranches of between three and 15 years, though longer maturities are available for certain issuers. “Private placements are sold to smaller groups of investors and as there is less expectation of any trading, they can be compared to the bank market,” says Jeremy Froud, Managing Director, Head of UK Debt Capital Markets at Barclays, who says tapping public markets and the US dollar market are the typical next steps that follow on from a US private placement.

The amount a corporate wants to borrow – the size or face value of the bond – will also influence the type of issue. Indices apply minimum size constraints, so smaller bonds will not be able to access the bigger investor universe of an index. In the UK, a bond has to be £250m or above to be included in certain indices; in Europe it is €500m. But although its bond issues started small, THFC has still been able to access the index.

“We tend to issue bonds in small sizes like £100m,” explains Edge. “These bonds are not benchmark size and not index eligible, but we then add to them, tapping the bond over and over again so it grows. We will have a bond of say £500m but that will have been achieved in four or five chunks.”

It is worth noting that treasury teams require board approval before they set to work. Some corporations go to the board on a case-by-case basis for approval, but at Vodafone borrowing is approved annually.

Refinancing risk

Getting the maturity right is another consideration that will vary from organisation to organisation. Vodafone’s key priority last August was to reduce its refinancing risk by lengthening the maturity profile of its debt when rates were low. “We were able to lock in long-term interest rates of 35-40 years at 2.6% on a euro equivalent basis before tax deductibility,” says Garrod. “Our post-tax borrowing cost is around 2% for 40-year money. The future economic environment is uncertain and the less frequently you go to the market to refinance, so you reduce refinancing risk.”

The maturity a corporate chooses will also depend on the purpose of the debt. If the bond has been issued to provide finance for a specific project, treasury may want to term the bond to match the point at which the project will begin to generate cash for the company. “It is difficult to see what a high-tech company will look like in 30 years, so you might see shorter maturities here. But a utility wanting to finance long-term infrastructure is likely to require long-term debt,” says Rory Renshaw, a Managing Associate at law firm Linklaters. Companies will also want to avoid different bond issues maturing at the same time.

Get rated

A key decision before deciding to issue in the bond market is whether or not to obtain a rating. A rating is generally required for public bond issuance and helps open the door to a wider investor universe. “A credit rating is used by fund managers to measure corporate performance and most indices only include rated bonds. Investors in public bonds don’t want an off-index bet by buying on an unrated basis,” says Barclays’ Froud.

“A credit rating is a measure of the likelihood of the company defaulting during the life of the bonds. Any credit rating, and particularly if it is investment grade, will increase the number of investors able to invest in you,” says Renshaw. An issuer with a high credit rating will pay a lower interest rate than one with a low credit rating; the higher the rating, the greater the investor appetite.

Acquiring a rating takes six to eight weeks and involves “SWOT analysis of your company” by the ratings agency. It will examine “in minute detail”, explains Froud, how the company compares to peers, as well as its historical performance, management structure and aspirations going forward, paying particular attention to any acquisition programmes that could put the credit rating under pressure.

The credit rating is also a vital piece of the jigsaw because it sets a company’s refinancing risk. “Every investor will buy a AAA but not every investor will buy a BBB,” says Garrod. Treasury teams have to weigh the increasing cost of capital as the amount of debt grows and investor appetite slows, with the fact that debt is tax deductible.

At the centre of this balancing act lies the credit rating. “Vodafone is likely to have debt forever,” says Garrod. “So, debt to us is permanent capital. Permanent capital is like equity, but needs to be refinanced. The better the rating you have, the lower the refinancing risk.”

Staying local

What happens if the credit rating is downgraded? It is not always a disaster, as the experience of THFC, which runs one bond programme that is guaranteed by the UK government, reveals. When ratings agencies downgraded the UK’s credit rating after the Brexit vote, the rating on THFC’s guaranteed debt fell too. However in this case it hasn’t made much of a difference.

“The lower rating really has been by-the-by,” says Edge. “For our last bond issue we achieved the tightest spread over gilts ever done.” Tight, or narrow spreads, reflect a cost of borrowing that is close to the sovereign and therefore relatively cheap. Edge adds: “We are a good match with the institutional market because they like investing in long-term residential property assets. Investors are also keen on long-dated sterling assets, and anything they can pick up over gilts is attractive.” Low investor returns from government bonds have helped create demand for riskier corporate debt that gives a better return.

“Vodafone is likely to have debt forever. So, debt to us is permanent capital. Permanent capital is like equity, but needs to be refinanced. The better the rating you have, the lower the refinancing risk.”

Neil Garrod, Director of Treasury, Vodafone

It is heartening news for treasury teams mulling issuing debt in the UK, but worried about the health of the UK sterling market. Indeed, Vodafone’s August issue was its first since 2009. That was the same year that UK companies had 50% of their outstanding corporate bonds denominated in sterling, according to research from Bank of America Merril Lynch. This has now dwindled to 28% as the euro and the US corporate bond markets have lured UK companies away with more favourable conditions.

Now the Bank of England’s 18-month £10bn bond buying programme begun last year is also boosting the market, believes Froud: “The Bank of England programme has put the sterling market back on the map. It shows the UK is open for business in a post Brexit world.”

Currency conundrum

Corporates can issue debt in any currency; deciding which is therefore another consideration. Organisations often choose the currency and location of their issue according to their revenues streams and where they do business. THFC issues all its debt in sterling because that is the currency required by the housing associations it lends to. Others may have acquisitions to consider. “If a UK corporate has just bought a company in the US, it could make sense to issue in dollars,” says Froud.

Vodafone, which trades its shares in sterling but uses euros as its functional currency, both runs a euro medium-term note (MTN) programme, and has a US shelf programme where it borrows in dollars to access the deeper US market. But for many, price is the driving factor.

“We issue debt in any currency, making the decision according to which is cheapest by comparing all borrowing costs when bought back into euros. It is basically a question of which currency is providing the best credit spread,” says Garrod. Corporations typically swap the issue currency into the currency it wants at the same time as the bond issue, in a strategy based on the overall cost being lower than if it had raised funds in the swapped currency.

Importantly, the MTN programme does not limit a company to borrowing only in euros. A euro MTN bond could, of course, include bond issues denominated in euros, but it could also be in any other currency from yen to swiss francs.

Corporates also issue in the currency where demand is strongest, and in many instances this is in the US. “We go where the market is deepest,” says Garrod. “Multi tranches do happen in Europe, but the US does them on a daily basis.”

Microsoft, which kicked off 2017 by borrowing US$17bn, is just the latest example. US investment grade, or low risk, corporate bond issuance reached US$1.2trn in 2016, breaking annual issuance for the sixth year running, according to IFR data. In contrast, in 2015 there was US$360bn of new euro-denominated corporate bonds sold in Europe.

Picking the team

The right team is another important consideration, particularly if markets are challenging. The banking teams behind Vodafone’s bond issues are drawn from the company’s relationship banks. “We have a backstop overdraft facility with a banking syndicate,” explains Garrod. “Although we have never used it, we could borrow from these syndicate banks if we needed to. The banks prepared to lend into this facility are our relationship banks and the quid pro quo, or the price of that subsidised balance sheet availability, is that they get to bid for our ancillary business.” Ancillary business accounts for a whole suite of banking services from FX transactions to currency swaps and, of course, bond sales.

A corporate could also opt for an independent advisor who is not acting as book runner, or providing services. “Some treasurers make their own decisions, others prefer advice,” says Froud.

Timing the market around strong demand is more important for corporates with a lower rating than for those with higher ratings. And teams have to anticipate any sudden macroeconomic news that could affect book building, the process when banks market the bond, taking orders and ‘building a book’ of demand.

Banks are also important for their role as underwriters of a corporate bond issue. This is not a guarantee of the successful execution. If the bond doesn’t clear, the bank doesn’t appear as borrower. Rather it refers to a commitment from that bank that in the unlikely scenario an investor says they will buy bonds but then doesn’t ‘settle’ – ie stump up the cash – then the bank comes in.

Other support services include a paying agent, who acts as an intermediary between issuers and investors, and a trustee, who is a spokesman for the bondholders. The team of investment bankers and lawyers doesn’t come cheaply. Banks charge a percentage of the issue and a legal team could range from tens to hundreds of thousands of pounds, says Renshaw.

Next comes the roadshow, when corporates travel the country selling the company to analysts, fund managers and potential investors. “The roadshow will quickly reveal whether the banks have got their pricing right,” says Froud. It is also a time when corporations are grilled on acquisition programmes, particularly plans to finance them through debt. Acquisitions may worry investors and “companies will need to put their vision across.”

For seasoned issuers like THFC, roadshows are almost a formality. “We may have a roadshow for investors, one-to-one or in a group, but there is not always a roadshow because investors know us well,” says Edge. At THFC, bond issuance has become a slick and well-worn process. The “documents are on the shelf,” drafting takes two to four weeks and the lead managers know the business and the sterling market well.

Herding cats

Timing the issue is the next priority. Vodafone has an eye on the market long before its bonds are due to mature. “We are an opportunistic borrower, not a calendar borrower,” says Garrod. “We think about when the right time is to refinance based on when credit spreads are low. We would happily refinance up to a year ahead of maturity if the market gives us a better level of financing.” No surprise then that last August, Garrod and his team seized the opportunity around the government’s efforts to boost the economy post-referendum, such as relaunching quantitative easing and buying up to £10bn in corporate bonds, to secure the lowest cost of borrowing possible.

Timing the market around strong demand is more important for corporates with a lower rating than for those with higher ratings. And teams have to anticipate any sudden macroeconomic news that could affect book building, the process when banks market the bond, taking orders and ‘building a book’ of demand.

At THFC, timing bond issues is driven by the needs of housing association borrowers, rather than by the market. Any bond issue involves gathering a critical mass of two or three housing associations ready to borrow between £50-70m. “We don’t issue debt and then sit on the proceeds,” says Edge. “We have to get our borrowers to come to the market together and it is quite complicated. We call it herding cats.” It means she is unable to time issues around market opportunity – although if she does have her borrowers ready, and sees an opening, she will make sure the borrowers are aware and able to come to market quickly.

At the end of the process can treasury sit back and relax? For Garrod, his eye is already on the secondary market, where investors who bought the primary issue go on to sell to other investors – and the next bond issue. “You want bonds to trade well in the secondary market because it encourages investors to participate in the next issue,” he concludes. “On the other hand, if they trade too well it means you’ve left a lot of money on the table!”