Buyers' risk appetite back as Europe alters debt menu

Investor appetite for Bank of Ireland bonds has changed a lot in the past four years.

In September 2009, the Irish lender, which received a €4.8 billion bailout during the financial crisis, was forced to offer investors a return of about 4.6 per cent to sell $US1.3 billion of 3½-year bonds.

Yet when the bank returned to the European corporate bond market last week, the yield had almost halved, to 2.75 per cent, on its $US650 million of unsecured three-year bonds. More important, the issuance was almost three times oversubscribed, as investors clamoured to secure access to the relatively risky bonds.

"Ireland has recovered strongly in the past couple of years," Deutsche Bank's Christopher Whitman said. "Many credit investors are now comfortable with Ireland."

The demand for Bank of Ireland bonds is the latest example of the credit boom gripping Europe.

Despite concerns about the Continent's wider economy, companies including multinationals like Siemens and Barclays as well as smaller firms have issued more than $US430 billion ($446 billion) of bonds this year, Standard & Poor's says. US firms have pocketed about $US380 billion.

The bonanza has eased the short-term financing troubles for many of Europe's struggling companies.

With banks cutting back on lending to meet more stringent capital requirements, the debt markets have given companies an opportunity to refinance maturing loans, often at reduced interest rates. The new financing has also helped offset the impact of dwindling sales caused by the financial crisis.

Even in debt-ridden European countries like Greece and Portugal, companies have found willing bondholders to back new issuances.

The Greek oil-refining company Hellenic Petroleum, for example, raised $US650 million in four-year bonds on April 30, after it offered investors an annual return of 8 per cent.

Portucel, a Portuguese paper manufacturer, also won backing in mid-May for its seven-year bonds, worth a combined $US455 million at 5.4 per cent.

In total, European companies have issued $US64.1 billion of high-yield bonds this year, almost double last year's amount, according to the data provider Dealogic.

Europe's banking sector has also got into the financing act.

Faced with regulatory demands to increase reserves, a number of large European financial institutions, including UBS of Switzerland and BBVA of Spain, have issued so-called contingent capital, or CoCos, to fill the void.

These complex instruments offer bond-like returns but convert to equity - or, in some cases, wipe out bondholders altogether - if a bank's capital falls below a certain threshold. European banks have raised almost $US5 billion through these products this year, and analysts expect more by the year end.

"CoCos are an attractive option for some of Europe's largest banks," said James Longsdon, at Fitch Ratings.

But while Europe's corporate sector has benefited from the near record amount of bond issuances so far this year, analysts worry investors may be setting themselves up for trouble.

As demand for corporate bonds has outstripped supply, many investors are now looking to buy debt from non-investment grade companies in the high yield market.

These companies once had to guarantee double-digit returns to entice investors to part with their money. Now, the average coupon, or return, on offer in the European high-yield market has fallen to about 6 per cent.

For some, that still represents a healthy return. But other investors worry the falling yields do not compensate for the dangers associated with backing these somewhat risky companies.

"Investors will get absolutely shellacked," said Robin Doumar, of Park Square Capital. "As rates rise, investors will get savaged by both interest rate and credit risk. This will end in tears."