Outlook 2012: High-grade primary sees Europe as biggest variable, banks challenged

By Andrea Heisinger

New York, Dec. 30 - The high-grade bond market was on a rollercoaster throughout 2011 as issuance became a slave to the headlines and moves in the equity markets.

According to Prospect News data, issuance totaled about $882.62 billion as of Dec. 23 and one syndicate desk predicted a 10% drop in new deal volume in 2012.

Another large syndicate is predicting a number "roughly flat to 2011, or between $725 billion and $750 billion in deals.

"Assumed in that number is a meaningful amount of M&A," a source from that large syndicate said. "There are a lot of 'ifs.' If the European issuers bounce back there could be more financing."

The debt crisis in euro zone countries was a big influence on the market and whether or not a company would price debt in 2011, and this will continue to be the main focus in the coming year, sources said.

"There are risks for 2012, including the European debt crisis - that one's obvious," said Jeff Meli, head of credit strategy for Barclays Capital.

"There were periods of ebbs, periods of increases in 2011. [We will] see something of the same pattern in 2012. When there's fiscal reform news or because of other factors, the market will be up."

A syndicate source from a large bank said that Europe "is the most important variable in the market right now."

He added that this will be the primary focus in the first quarter of 2012, and that some of the volatility needs to go away.

"This year we had days when the equity market was way down and big deals got done, and others when equities hardly moved and no one wanted to jump in. It's hard to tell anymore," the source said.

There were three themes to issuance in the past year, the syndicate source said. There were a lot of inaugural borrowers, financing for mergers and acquisitions, and financing to return money to shareholders.

Volatility to affect spreads

There was plenty of volatility in 2011, making it difficult to predict issuance from one day to the next.

"It was so volatile that you went out with an issue in the morning and had no idea what would come out [in the headlines] by the time it was priced," a market source said.

It's unclear how the situation with Europe's debt and other financial regulations domestically will shake out in the coming year, and spreads are likely to be affected.

"There is a regulatory element in the poor performance of investment-grade credit," said Barry Knapp, chief market strategist at Barclays Capital.

He referred to three things: Basel III, which is a global regulatory standard on bank capital, stress testing and market liquidity risk; the Volcker Rule that prevents domestic banks from making certain speculative investments, and the parent of this rule, the Dodd-Frank Wall Street Reform and Consumer Protection Act, which deals with financial regulations.

"Some clarity in the first quarter [on how the regulations will affect banks] will help," Knapp said. "It's the big unanswered question on the Street, and poor performance in IG credit can be blamed for this."

Meli, the head of credit strategy at Barclays, said that there will be higher spreads and new issue premiums on European investment-grade names in the short term.

Over the course of 2012, he added, the high-grade market will end up in a better place, although he cautioned that there's a limit to how low spreads can go.

"Poor liquidity is a limit on the market," he said. "There's potentially higher volatility. Spreads will have massive swings."

Financials in Europe's shadow

It's unclear how much the euro zone debt crisis will affect financial names in the coming year, but big banks will still need to access the debt markets.

"The large money banks would not need to tap the market in the next year, but it would be irresponsible for them to do that," Meli said.

U.S. banks have a lot of links to the European banking system, Meli said, adding that "trying to understand the interlinkages between the banks is impossible."

Corporates, on the other hand, have small, direct exposure to Europe and are impacted less directly.

The new issue concession is expected to remain volatile in the coming year, Meli said.

Financials are expected to pay the most concessions going forward.

"There are concerns on the increased volatility of financials," said Brad Rogoff, head of U.S. credit strategy for Barclays Capital. "Liquidity challenges will be a big part of it. There will be a liquidity premium."

The volatility's effect on bank liquidity that surfaced in 2011 is another concern for 2012, sources said.

"It remains to be seen if we maintain a pre-Volcker [Rule] level of liquidity in the system," Meli said.

"Dealers are not making the markets and no one else is stepping up to do it. There's a global effort to make bank balance sheets smaller."

Companies in good position

Many issuers accessed the debt market in the second half of 2011 due to low borrowing rates and uncertainty ahead, sources said. Companies are looking at a lot of cash on their balance sheets, but that doesn't mean they will sit the coming year out.

"Businesses have never been healthier than they are now," said Benjamin Pace, chief investment officer and head of global investment solutions at Deutsche Bank Private Wealth Management.

"They have a low debt ratio and high cash reserves. They're going to have cash to spend on capital needs and share buybacks."

His colleague, Owen Fitzpatrick, chief investment strategist for equities at DB Private Wealth Management, said that companies are "generating a tremendous amount of cash and paying off debt.

"They're in great shape," he said. "The capital markets aren't going to sit around and wait for the federal government to get their act together."

Still, new issue concessions that were high in the last quarter of 2011 are expected to remain that way, and that could affect whether companies access the market.

Single A rated names have been paying a premium between 15 basis points and 20 bps in the last part of the year, and mid-to-weak BBB names paid between 40 bps and 60 bps, a syndicate source said.

"It feels like [new issue concessions] are where they haven't been in seven to eight years," the source said. "We hope they subside."

Tentative start to deals

Previous years have seen a rush of new deals in January and February as companies get their large chunks of financing for the year done early.

That could change in 2012, sources said.

"We don't have a huge pipeline for January," a market source said.

"We've had two or three deals that keep getting pushed back from companies that were eyeing the market in the last couple of weeks this year, but haven't been able to go. Early January's not looking overwhelming with new deals," the source said.

Another syndicate source at a large bank said that January and February will be not quite as busy as 2011.

"If people had meaningful financing to get done, they accelerated those plans due to Europe," this source said.

The market source said that financials especially front-loaded at the beginning of 2011, and "with rates so low" toward the end of the year, people moved up their financing needs.

A big variable for the coming year is financial institutions with limited capacity to borrow, the syndicate source said.

"Banks could be more active this year [2012] because they were shut out of the market for parts of 2011."

Corporate issuance from non-financials is looking flat, although some sectors such as retail and consumer goods issued a modest amount in 2011 and could do more in 2012, the source said. Even if companies are sitting on a lot of cash, they still need to leverage their balance sheets, he said.

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