COVER STORY: CORPORATE DEBT
A gargantuan wall of debt coming due over the next few
years could impede all but the highest-rated corporations'
efforts to refinance their debt.
By Jonathan Gregson
Just as the United States and other developed economies are
emerging from recession, with GDP growth returning and strong
corporate earnings pushing stock markets back up to pre-Lehman
levels, another bogeyman is waiting to pop out of the wings. Once
again, it's a hangover from that free-spending era of easy credit
that was the mid-noughties. But this time it's not mortgage-backed
securities or consumer credit that is the problem. It's
longer-dated corporate and government debt that is coming due for
refinancing from 2012 onward. And the numbers are awesome.
Massive demand for new money from capital markets is going to
come from right across the spectrum, from ostensibly risk-free
triple-A-rated sovereigns such as US treasuries, through
investment-grade corporates, to high-yield (and therefore
high-risk) junk bonds.
Come 2012 some $860 billion of US government bonds will reach
maturity and need refinancing. Add to that an anticipated federal
deficit of $974 billion, which will also need to be funded, and the
US government's demands on capital markets amount to more than $1.8
trillion. And a further $1.4 trillion is called for each year
through to 2014.
Over precisely the same period, a huge swath of companies that
borrowed on easy terms between 2003 and 2008 will be seeking to
roll over their debts by taking out new loans or issuing bonds-the
usual maturity for corporate debt being five to seven years.
Analysts at Credit Suisse estimate that $34 billion of US
high-yield bonds will mature this year, but by 2015 nearly $120
billion of junk bonds will reach maturity and therefore need
That may be a headache, but the real problem lies elsewhere,
with the mountain of leveraged loans taken out by
sub-investment-grade companies during the boom years. Whereas only
$24 billion matures this year, from here on debt retirement rises
steeply to peak at $290 billion in 2014, according to Credit
The same is true across the Atlantic. Just €6 billion of
leveraged loans will mature in Europe this year (figures include
the Middle East and Africa). By 2014 that rises tenfold to €61
billion. The outlook is better for European high-yield bonds, where
redemptions rise gradually from €15 billion this year to peak at
€23 billion in 2014.
Mind the Gap
Clearly, both the United States and Europe are facing a huge
funding gap. Credit Suisse estimates that in the US approximately
$560 billion above the capital market's normal capacity for new
issuance will be needed between 2012 and 2015 to refinance retiring
loans and junk bonds. In Europe the crunch comes slightly later,
with some €255 billion needing to be refinanced between 2013 and
2016. The numbers may get even scarier, as these forecasts exclude
"fallen angels" that slide from being investment-grade to
high-yield issuers, companies that default during the profile
range, and all new issuance that could crowd out refinancings of
"There is a wall of redemptions out there," admits Jean-Marc
Mercier, European head of global syndication at HSBC, "but we are
very optimistic about the market's ability to respond." Mercier's
confidence is partly due to the combination of negative real
interest rates, quantitative easing and the rapid return to
"normality" of most capital markets, which has created an
exceptionally benign climate for both financial sponsors and
Then again, the move by many corporates toward paying down their
debts and reinforcing their balance sheets means there is less
demand overall, while today's relatively low levels of M&A
activity translate into fewer calls for genuinely new issuance.
Nonetheless, with the high-yield sector alone facing a funding
gap of close to $1 trillion globally, new money must be found to
get through the "maturity wall." And now that banks are generally
much more cautious in lending to companies, the bond markets will
have to take up the slack.
"There is a broad shift among corporates away from bank lending
to bond markets," says Mark Lewellen, head of European corporate
origination at Barclays Capital. "Companies are increasingly aware
of the benefits of diversifying their sources of funding," he adds,
noting that previously unrated companies are now looking to issue
The abrupt shift from bank financing to bond markets is even
more pronounced in Europe, according to Ian Falconer, finance
partner at London law firm Freshfields Bruckhaus Deringer, because
most European companies have traditionally looked to their banks
rather than capital markets for funding (the reverse is true in the
So far, corporate bond markets have comfortably absorbed rising
demand. "Last year saw a record $200 billion of high-yield issuance
globally," says Mathew Cestar, co-head of the credit capital
markets group in the Europe, Middle East and Africa (
) region at Credit Suisse. The first quarter of this year has been
the busiest ever, with $85 billion of deals done, he says, adding
that "the lion's share has been refinancing as corporates are
looking to refinance ahead of the big hurdle coming up in the next
two to three years."
Many corporates are adopting the same approach, which may cause
its own set of problems. Ronan Clarke, head of high-yield research
at Nomura, agrees: "Many companies are dealing with maturity issues
early, but this leaves the worry that, when we get closer to the
cliff coming up in 2011-2012, weaker credits will all rush to
refinance at the same time." Cestar notes that in Europe alone more
than €250 billion of refinancing needs to be done in the next few
years. "Companies want to secure their funding to take them beyond
that period," he says.
The Calm Before the Storm?
For the present, at least, companies can still raise money
relatively cheaply. "Many corporates are de-leveraging," says
Mercier, "so there is not enough issuance to meet investor demand."
In Europe, for instance, some €119 billion of investment-grade and
high-yield bond issuance was completed in the first quarter last
year, while for the same quarter in 2010 issuance plummeted to €50
billion. As a result, Mercier says, "the dynamics of supply and
demand are moving in favor of corporates looking to raise
"There is still not enough supply to satisfy demand," says
Cestar, pointing to recent transactions in Europe that have been
many times oversubscribed. That is equally true of the US market
where, notes Dirk Leasure, the New York-based head of BMO Capital
Markets financial sponsors group, there is currently "a tremendous
pool of capital-some estimate it at $400 billion-held by financial
sponsors looking for investments."
Driving that investor demand is the search for enhanced yield in
today's low-interest-rate environment. Or, as Rik Fennema of
Nomura's investment-grade research group puts it, "Money needs to
be put to work, and there's a lot of retail money that entered the
market because savings accounts offer so little return." Mercier
adds, "Only a massive rally in yields when short-term rates start
rising will dampen that demand."
The same momentum is present in Latin American markets, which,
says Michael Fitzgerald, head of Latin American practice at Milbank
attorneys, have been arguably the best place to invest over the
past year. He points to a string of high-yield eurobond offerings
coming out of Mexico, Brazil, Colombia and Peru, beginning last
July with the Mexican group Javer sporting a 13% coupon. "Since
then," Fitzgerald says, "we have seen close to 40 high-yield
issuers out of Latin America, and the spreads have tightened, with
the Mexican pulp and paper group Scribe paying less than 9% after
its oversubscribed bond issue was increased from $200 million to
$300 million." He adds, "This market is really on fire, and Latin
American companies all want to go ahead now."
Some investors, notably the Japanese, are more cautious.
"Investors looking outside their home market are generally more
selective and go for lower-risk credits," says Fennema at Nomura.
"Don't expect to find Asian investors dipping into Mittelstand or
smaller, unrated companies soon."
Investors Seek Yield and Influence
Strong investor demand in high-yield corporates is enabling
sponsors to become more creative in how they deploy capital,
Leasure says. "Many prefer to invest in a company's debt," he says,
"and use that as a tool to help the company restructure its balance
For example, rather than going for a straightforward equity
capital injection, thereby becoming an investor with a minority
ownership position, some sponsors are buying up a company's debt in
the secondary market and then exchanging it with the company for
new equity, and perhaps a larger ownership position."
Convertible bonds, where bondholders can convert into equity in
the company, are also broadening in scope. "Whereas last year it
was mostly investment-grade companies issuing convertible bonds, as
the cost of financing has fallen more, high-yield or unrated
companies are entering the market," says Simon Ollerenshaw, head of
European convertible origination at Barclays Capital. He sees a
window of opportunity for companies to issue convertibles based on
today's high stock prices, either to replace existing senior debt
or to finance M&A activity without having to go back to
shareholders with another rights issue.
CFOs must work out in advance the immediate cash-flow benefits
of convertibles' lower coupon against the diluting of shareholders
when the bonds convert to equity. "There exists a wide group of
unrated companies for whom convertibles are a more natural home
than straight debt markets," says Ollerenshaw.
Buoyant capital markets are currently permitting private equity
and other leveraged investors to cash in. Clarke points to the
re-emergence of "dividend deals," where LBOs issue a bond or raise
new debt in order to distribute cash to shareholders rather than
for investment purposes or restructuring the balance sheet.
At the same time, investors are seeking greater protection in
the wake of the financial crisis. "The way European bonds are
structured has improved, so that with senior secured bonds
broad-based investors virtually step into the shoes of bank
lenders," says Cestar.
Lewellen notes that often the terms and language are more
specific, to provide a greater level of comfort for investors. "For
instance, unless the bonds are rated within a specified period, the
coupon [rate of interest] steps up. Alternatively, if the company
loses its investment-grade rating, then the coupon is increased,"
he adds. Among investors, Lewellen sees tremendous liquidity and
appetite for a broad range of assets. "Rather than just appealing
to high-yield specialists, they are now attracting a broader range
of investors," he notes.
Cash call: Companies and governments are being advised to
deal with their future funding needs now, while demand for debt
is still robust
Fitzgerald says bond investors are also enjoying a tightening of
legal protection, although "very few of these bonds are secured
against assets as bank loans would be." With better-structured
bonds attracting the broader investment community, he sees "a new
international asset class emerging." However, Falconer points out
that the restructuring of debt and tighter covenants can mean that
some bondholders further down the chain are effectively being
Many companies are already addressing their funding needs ahead
of the impending wall of redemptions. "A string of highly rated
companies issued bonds last year, raising more than they
immediately needed, just in case of another financial meltdown,"
observes Mercier. For smaller corporates that have traditionally
appealed to local investors, the higher yields currently being
demanded by the market for new bonds issued by troubled governments
such as Greece, Spain or Portugal is effectively raising the price
of their own refinancing. Some major players like the Spanish
telecom group Telefónica refused to pay a higher price, says
Mercier, and waited for markets to normalize.
Falconer points out that there is a mountain of bank debt that
also needs to be rolled over from 2012 onward, and that further
calls will be made on equity investors through rights issues.
"There is a possibility of a bottleneck from 2012 to 2014," says
Mercier, "but corporates are already very busy solving that
Jumpy Buyers Prompt Volatility Spike
Possibly the greatest threat to successful refinancing at
competitive rates will come not, as previously, from high-profile
companies defaulting or a string of downward ratings movements but
from weakness in the market for government bonds. "Sovereigns
crowding out the market could have some effect on corporates'
issuance plans," says Mercier. And if returns on sovereigns and
highly rated bonds start rising, more leveraged entities might be
expected to have difficulty in accessing the marketplace.
That almost happened last February. "The high-yield market
faltered earlier this year," says Mercier, "because spreads over
safer bonds had tightened too far." The root problem this time was
the Greek government bond issue in January, which turned sentiment
in all markets, according to Sean Taor, head of rates syndication
at Barclays Capital. "With the return of risk aversion, volumes of
new issuance dropped by 50% across all sectors in February," he
Since March, sentiment has bounced back, though heightened
volatility still poses a problem for corporates planning to tap the
market. And with the success of further auctions of Greek bonds
still looking uncertain, Taor warns that we are not out of the
"Truly global investment-grade corporations that can count on
investor demand have time to arrange their refinancing," says
Mercier. But for less highly rated companies with redemptions
coming up, he advises that "they should be taking action now, while
yields are low and margins compressed."
In other words, groom the company and issue the bonds while the
window of opportunity is still open. Those who fail to act now may
find themselves driving full speed into the wall of