corporate funding monitor 2016

Corporate funding monitor 2016The changing face of finance

January 2016

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Despite volatility and complexity, corporates continue to have funding options

Looking back, 2015 was quite a year. Financial markets were volatile as they absorbed an onslaught of new risks, from the growth slowdown in China to the collapse in oil prices.

A series of heavy new financial regulations, designed to reshape the sector, also came into effect early in the year.

Yet, corporate funding still reached near record levels at USD6.02 trillion, according to Thomson Reuters data analysed for this report. This is only the second time combined financing has exceeded USD6tn and just 6% down on the peak achieved in 2014.

Companies found they could raise money more cheaply and in more ways

than ever before. The new normal that is emerging for corporate funding is a lot more complex than it used to be, but it’s working.

The clearest trend in 2015, strong in both the U.S. and Europe, was the return of investment grade loans as the largest source of funding for high quality corporates, up 6% to USD1.65tn – pushing close to the pre-crisis peak of USD1.71tn in 2007.

This also saw the value of investment grade loans exceed the value of investment grade bonds for only the second time since the financial crisis.

The increase was driven by the merger and acquisitions (M&A) boom and, in particular, the return of megadeals

such as Anheuser-Busch Inbev’s bid for SABMiller and Royal Dutch Shell’s bid for BG.

These deals required large-scale short-term bridge financing which made up a sizeable share of the total: of the USD360 billion lent in the top 20 investment grade deals, 38% was bridge finance. M&A was also the driving force behind a record year for follow-on equity issues, which reached close to USD450bn for the first time in 2015.

The bulge in short-term finance has resulted in a sharp rise in the number of loans scheduled to mature in 2016. Almost USD860bn of investment grade loans matures in 2016, compared with half of that amount in 2017.

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Corporate funding – by source, global (USDm)

The Allen & Overy Corporate Funding Monitor looks at loan, bond and equity issues to non-financial corporates over the past decade to see what impact regulatory pressures, bank deleveraging and the emergence of alternative sources of finance have had on the way companies access funding. The data is taken from Thomson Reuters and excludes funding to financial and real estate companies.

Corporate funding monitor 20162

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Even with the prospect of rising interest rates in the U.S., however, refinancing risk will remain low for investment-grade corporates for three reasons.

First, the increases look set to follow a gradual path. The Federal Reserve’s own projections imply rates around

2.5% by the end of 2017 and 3.5% over the longer term – still far lower than the peaks seen over the past few decades.

In Europe a further round of quantitative easing was ushered in last year, increasing the volume of cheap debt available for corporates.

Meanwhile the UK looks set to hold off a little longer before it begins to raise its rates.

No matter how you look at it, it will be a long-time before corporates have to worry about interest rates approaching 5%, as they were pre-crisis.

U.S. interest rate history and FOMC projections

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Secondly, the maturity profile for both bonds and loans is very stable over the next five years with roughly USD3tn of debt maturing each year.

Most of this is likely to be rolled over before reaching maturity to take advantage of still-low interest rates.

In summary, investors’ appetite for investment-grade paper, the historic resilience of the high-yield and leveraged loan markets and access

to various forms of alternative finance, means there should be adequate demand to meet the pipeline of maturing debt over the next 12 months.

Many commentators also anticipate the appetite for M&A will continue in 2016. For investment grade borrowers, a modest increase in rates will make little difference to the affordability or availability of funding. Banks remain keen to finance good-quality deals

and there is increasing competition to finance mid-market deals they might previously have considered too small

This reflects the diminishing returns on top-end large deals, where margins are currently very low and making a loan is often only attractive as an entry ticket to a broader and more-profitable cross-selling relationship with the borrower.

Five-year maturities for bonds and loans – global (USDm)

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One post-crisis trend the 2015 M&A-fuelled boom in short-term finance has reversed is the primacy of bonds in the investment grade market.

Pre-financial crisis the value of loans was double the value of bonds. As the credit crunch of 2007 gave way to a full financial crisis, markets dislocated and investment grade corporates turned to bonds to meet their funding needs in record numbers.

Over the past three years the volatile post-crisis relationship between loans and bonds, looks to have settled with the value of bond issues and loans to investment grade borrowers stabilising to a position of parity.

If, as anticipated, the short-term bridge loans used to fund the M&A boom are refinanced in the bond markets during 2016, bonds will most likely take pole

position again. But the difference in value between loans and bonds will likely remain small.

Market currents continue to fluctuate depending on which prevailing events and conditions have the strongest pull on the tidal flow of funds. But one thing is clear – corporates have options and are willing to use any and all of them as necessary.

Investment grade financing – global (USDm)

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More flexibility in European funding

While investment-grade lending soared, other parts of the market have not been without their challenges, most notably in leveraged loans, which dropped sharply in 2015 after two years of strong growth.

Investor demand in the U.S. high-yield bond and leveraged loan market collapsed late last year, driven largely by the deterioration of the oil and commodities sectors. Also, investment banks were unable to syndicate financing commitments made in relation to several large leveraged buyouts, further dampening the market. New leveraged lending guidelines from the Federal Reserve on maximum acceptable leverage for deals, also contributed to a drop of 38% year-on-year for new leveraged loans. Meanwhile the European high yield and leveraged loan market has been somewhat insulated from these circumstances, although it had to contend with the volatility resulting from the Greek crisis.

Sub-investment grade lending will remain more vulnerable to uncertainty and tighter credit conditions than investment grade loans, but the drop in leverage deals has not scuppered the trend towards greater flexibility in the European market.

Indeed, U.S.-style covenant-lite loans accounted for around half of European leveraged lending in 2015 according to S&P Capital IQ.

There has been a well established tradition of U.S. trends being exported to Europe. While European credits have historically tended to tap the U.S. markets for better terms, 2015 saw some

of that flow begin to reverse. QE and lower prevailing interest rates in Europe could attract more U.S. credits to the European high-yield market, with structures that are increasingly familiar to American corporates, due to lower all-in-yields. The strength of the U.S. dollar may also make issuing Euro denominated debt attractive for companies with U.S. dollar revenues. Finally, European high-yield funds have been less invested in the oil and commodities sectors, and as a result have been somewhat insulated from the volatility that has affected their U.S. counterparts.

Another key development has been the maturing of the European high-yield bond market. Although issuance dropped markedly to USD80bn from USD124bn in 2014, the value of high-yield bonds has more than trebled from just USD26bn 10 years ago, and now accounts for around one-fifth of the wider European corporate bond market.

Issuing a high-yield bond for general corporate financing requirements is now an acceptable alternative to bank lending for any sub-investment grade borrower in Europe, whereas historically it was predominantly viewed as a tool for financing leveraged buyouts.

High yield has also become attractive for smaller issuers and deals, which should ensure that the market continues to grow despite greater investor appetite for covenant-lite loans and a shift to alternative financing.

The growth of the European high-yield market may well be aided by the addition of U.S. issuers over the next couple of years.

Despite headwinds, the U.S. high-yield market should also remain the well established feature of the U.S. markets it has always been. Spreads have been rising, especially among the lowest-rated issuers, and investors are becoming more selective, but this largely reflects the problems in the oil & gas and mining sectors (which account for a larger share of high-yield issuance in the U.S. than in Europe) caused by falling commodity prices.

The difficulties in these sectors are unlikely to result in widespread contagion and drastically reduced liquidity.

Meanwhile, rising interest rates will be counteracted by the strengthening U.S. economy that is causing them to rise – traditionally a positive environment for high yield in the U.S.

The new normal

The structure and sources of corporate funding have changed dramatically since the financial crisis, responding to fast-shifting market dynamics and regulations. Despite the ups-and-downs, the overall level of funding has stabilised and the data are starting to show patterns and trends that look set to continue.

While banks still have to work to find profits, corporates are enjoying easier and cheaper access to investment-grade loans if they are eligible, and a wider variety of sub-investment grade alternatives if they are not.



Technology and healthcare will drive IPO market in 2016

Initial public offerings (IPOs) got off to a strong start in 2015, but momentum slowed, largely as a result of the volatility in China during summer 2015 and the ease of raising private funding in the U.S. – proceeds from IPOs in Asia Pacific (excluding Japan) halved in 2015 from 2014 levels and IPOs in the Americas were down 35%. While still well below 2006-2007 levels, Europe was by contrast a relative bright spot – only down 9% year-on-year. Last year’s total included the successful completion of a number of deals postponed from the end of 2014 and a handful of large privatisations of

state-owned assets, such as the IPO of Spain’s airports operator Aena. Activity also included a high proportion of private equity exits, continuing a trend from 2014.

This proportion is now declining as the pipeline of good private-equity assets that are ready for IPO shrinks. With fewer large private equity and state-owned assets likely to come to market, 2016 is likely to see a greater focus on mid-cap floats. There is a significant pipeline of smaller technology companies yet to come to market, and healthcare may also prove a popular sector.

Is liquidity a risk for the high-yield market?

One potential concern for the U.S. high-yield bond market is that issuance has grown at a time when the ability of banks to act as market makers in corporate bonds has been curtailed. In the past, banks’ bond trading desks have been willing to hold substantial inventories of corporate bonds, allowing them to perform a stabilising role during periods of market turmoil. But new regulations such as the such as Dodd Frank have made it more expensive to hold these instruments and bond inventories have consequently declined sharply in recent years.

If investors were to exit the high-yield market due to rising rates or increased defaults, the fear is that liquidity could suffer since banks would be unable to fulfil their traditional role. A report by Invesco notes that the inventory of U.S. corporate bonds held by primary dealers has declined from a peak holding of about 10% of the market in July 2007 to just over 1% in 2015. While this does not appear to be an immediate threat, it is an illustration of how regulatory changes aimed at reducing risks could have unpredictable consequences.

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Regional snapshots

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Africa/Middle East/Central Asia

Total funding to corporates in Africa, the Middle East and Central Asia rose 42% to USD164bn, exceeding the previous high of USD160bn in 2007. However, as the graph below illustrates, the trends by funding method varied widely. Issuance of loans grew 64% in 2015 to a new high of USD132bn, making up 80% of the funding mix and exceeding the previous high of 75% in 2007. This perhaps

shows that banks are shifting their balance sheets away from a stagnant Europe and are still willing to lend in regions with growth potential. Bond issuance declined, falling by almost 40%. The profile of maturities over the next five years is relatively flat for both loans and bonds, until 2020 when loan maturities spike.

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Corporate funding by source (USDm)

Corporate funding maturity by source (USDm)



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Asia Pacific (excluding Central Asia and Japan)



There was a decline across all funding categories in Asia excluding Japan, reflecting slower economic growth across the region. The decline was greatest in bonds, where issuance fell 40%, reversing the 40% increase seen in 2014 during exceptionally strong year for investment-grade bonds. However, 2015’s total of USD320bn was still the second-highest on record and bonds accounted for more than 35% of corporate funding, compared to less than 20%

10 years ago. While equity was relatively flat year-on-year, this masks the drop-off in IPOs mentioned earlier, which fell by 48%, while follow-on offerings increased by 24% to the highest level of USD171bn. More than USD200bn of outstanding bonds mature in both 2016 and 2017, the only region where the volume of bonds to be refinanced exceeds the volume of loans.

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Americas



Corporate funding in the Americas rose to USD3.15tn, beating the previous high of USD3.06tn in 2014. Bond issuance rose to a record of almost USD1tn, with investment-grade bonds up 16% to USD754bn, also a record high. While loan issuance overall only increased by 1%, investment-grade loans grew by 52% to another record high of USD859bn. Follow-on offerings were up 7%, helping to offset the 35% drop in IPO proceeds so equity overall in the Americas only

fell by 2%. With the ongoing economic troubles in Latin America’s largest countries, Argentina and Brazil in particular, corporate funding in the Americas outside the U.S. was a completely different picture – down 22% overall, with bond issuance down 47% and equity down 19%. Loan maturities peak in 2016, to more than USD1.2tn, much of which can be attributed to short-term bridge finance for M&A deals announced in 2015.



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Europe



Europe saw a sharp drop in total corporate funding across all funding types in 2015, falling to USD1.5tn from USD1.7tn. This reflected a number of headwinds, including the extent to which the Greek debt crisis unsettled markets for much of the year. However, the M&A boom still had an impact in Europe. Investment-grade loans were up nearly 250% to USD580bn in 2015, just above the previous high of USD578bn in 2007. While overall issuance of new equity

was down 18%, IPOs performed relatively well by comparison, declining by 9%. Europe was the only region to see a drop in follow-on offerings. Almost USD700bn in loans is set to mature in 2016; as in the Americas, much of this is bridge finance for M&A deals.

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corporate funding monitor 2016

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