April 3 (IFR) - I've been spending a lot of time delving
into the debt financing of European mid-market corporates, and
I'm increasingly in the camp of those who reckon we're at the
start of a major shift in bond market activity as we move
towards a more heavily disintermediated funding model.
I don't think that's overstating the case. I'm calling it
The New DCM Paradigm. It will almost certainly take some years
to evolve fully, but we're already on the road and things are
moving pretty quickly.
The reasons for the shift are clear. Bank deleveraging,
higher capital requirements, more stringent financial regulation
and more value-focused client-relationship models are leading to
a broad withdrawal of "free" relationship-type bank lending -
not for all, of course, but banks are certainly maintaining
smaller groups of core clients. That's the push factor.
Current technical conditions in the bond market are the pull
factor, acting like a magnet for corporates of all sizes and
types. And the advantages of diversified sources of funding are
always appealing to corporate treasurers.
We're just at the beginning of this putative transformation
and it's yet to be tested. One robustness test for the
lending-to-DCM hypothesis will be what happens when the current
phase of central bank stimulus ends and we start to see a
normalisation of yield curves, higher credit spreads and (by
definition) higher debt-service costs in the bond market.
Another will be when - eventually - we get some modicum of
sustainable economic growth that allows confidence to return.
It's anyone's guess how banks will react to that. They're
maintaining tight discipline around RWA growth at this juncture
because they've got their backs to the wall on capital and cost
But by the same token, banks have been notoriously fickle in
the past around supposedly hard-held beliefs. And they may once
again open the credit taps if they can see growth (read: a
One thing is for sure: whatever outcome we ultimately
encounter, the bond cat is out of the bag - and corporates will
seek increasingly to maintain balanced bond and bank lines.
Price could be a determinant here. It seems to be a given
that funding in the bond market is likely to come out more
expensive than bank finance, but I wonder.
On the basis that the costs of banks' own funding is likely
to stay relatively elevated - and that those costs will have to
be passed on to borrowers with a premium if banks keep
stringently to market-based lending models and sweat their
assets to generate higher returns on capital employed - it's
likely that the basis differential may be minimal, depending on
what the buyside demand drivers are in the bond market.
The arrival of hordes of new mid-market borrowers into DCM
has the potential to cause major upheaval, and you've got to
question whether borrowers will be forced to adopt a stance that
suits the status quo - or whether the status quo will need to
change to suit the new borrowers. My money is on the latter.
One example of what might need to change is the current bond
market attitude to (and obsession with) liquidity. Another is
multiple bookrunning tickets. Investors like to demand
illiquidity premia unless issue sizes are US$300m-plus, which
frankly has never been anything more than
price-chiselling-cum-blackmail in my view.
Mid-market issue sizes will typically be much reduced, and
so won't be liquid. In that respect, they'll tend to appeal to
buy-and-hold buyers, be they retail investors or private
placement specialists. In this respect, I can see the
development of a bifurcated horses-for-courses model, but one
where investors craving diversified corporate exposure will do
whatever is required to get bonds.
ENTER BOND EXCHANGES
One development that will have a major impact on the
development of a European corporate bond market is the creation
of bond platforms on European stock exchanges, or a
re-invigoration for those have already have them.
Exchanges have made a big play to attract bond business in
Europe in the past two to three years, and the signs have been
encouraging. DEME, the Belgian marine engineering group, became
the first issuer of bonds on NYSE Alternext in Brussels in
February with a EUR200m six-year offering.
In late March, Cerved Technologies was the first issuer to
list its bonds on the Borsa Italiana's new ExtraMot Pro bond
platform, which is geared to professional investors. The company
listed its EUR250m due 2019 and EUR300m due 2020 senior lines
and its EUR230m due 2012 subordinated notes.
In a similar vein, Nasdaq OMX Group, which runs the
exchanges in Copenhagen, Stockholm, Helsinki, Reykjavik and the
Baltic countries, launched the First North Bond Market in
To provide some marketing oomph to the launch, Danish Crown,
the international food producer, listed its DKr750m (US$129m)
bond on the new market's first day of trading. The issue had
received a positive reception; Danish Crown had initially gone
out with a DKr500m-DKr750m range but sold the full amount to a
group of 73 investors.
Right across Europe, exchanges are getting in on the act. As
well as the initiatives I've already mentioned, Stuttgart Stock
Exchange's Bond segment now has 23 corporate bonds worth an
aggregate EUR1.5bn, while other exchanges are making efforts to
garner mid-market business, including M:access (Munich Stock
Exchange); Entry Standard for Corporate Bonds (Frankfurt);
Mittelstandsboerse Deutschland (Hamburg and Hanover),
mittelstandsmarkt (Duesseldorf); AIAF (benchmark corporate debt)
and SEND (electronic retail trading platform) in Spain; the
Nordic Alternative Bond Market in Oslo; the Third Market in
Vienna; and others.
The benefits of listing and trading with transparency via
organised exchanges with transparent rules are clear to both
issuers and investors. So will this New DCM Paradigm take over
the existing OTC market? Not in the short term. Are DCM
originators taking due notice of this emerging market? Not to
the extent they should. Is the DCM underwriting architecture
optimally organised to deal with this market? Not at all.
I sense a revolution in the making. The mid-market is
coming. Prepare for change.
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