Picture the scene: a meeting room, 40 floors up, plate glass floor-to-ceiling windows with views of central London in the background. At the polished mahogany table sits Hans Schmidt, the CFO of a major consumer global goods company. In walks Chad “Ace” Jefferson III, the latest in a long line of investment bankers assigned to cover his company. Behind Chad follows an entourage of five impeccably dressed junior bankers, whose sole purpose seems to be to carry Chad’s presentation packs.
“Hans! Buddy! High five!” Chad almost shouts as he bounds across the room with his hand raised.
Hans looks at him blankly, refusing to reciprocate the vulgar greeting. Instead he gets up and offers a handshake.
“Hello Mr. Jefferson,” he mumbles, already slightly irritated.
“I love you Swiss guys, so formal! It’s awesome!” says Chad beaming widely, shaking his hand.
“Yes, well, I agreed to this meeting because you said you had a once in a generation opportunity for our business Chad, if you don’t mind, let’s get on with this yes.”
“Alriiiight! Let’s get to it.” Chad turns to one of his entourage. “Jean-Philippe” he barks, “Get your ass in gear, give Herr Schmidt a presentation, chop chop!”
“OK so I’ll cut to the chase,” he says, pushing aside the presentation that Jean-Phillippe had worked on until 4am that morning. “Now that the ECB has finally got with the programme and done some good ‘ol fashioned QE, a good chunk of the European government bond market is now trading at negative yields. This means the scope for funding your business on the cheap is better than ever my friend. Here’s the thing …”
Chad leans towards Hans and almost inaudibly delivers his killer blow.
“With our help, your company, Hans, could issue a bond with no cost to the company.” Chad leaps to his feet and starts pacing around.
“I’m talking no coupon Hans! Free money! No interest rate! This is a thing of beauty. Think about it, a €500m bond issued at zero cost of financing. We can re-finance a big chunk of your debt and reduce the interest costs to zero. This baby feeds straight to the bottom line. I’m talking major EPS benefits buddy. Your board will love you for it Hans. It’s a no brainer! BOOM!” To emphasise his point, Chad slam-dunks the presentation into a nearby bin, causing Jean-Phillippe to wince.
Hans turns to Chad and says, “OK, so you have my attention. This sounds interesting. But why would any investor buy my company’s bonds without a positive coupon? Does that not defeat the whole point of a corporate bond?“
“Great question Hans! It’s a case of choosing the lesser of two evils here. If you are a bond investor, buying a corporate bond from a respected company like yours for zero return, it may well be a better option than buying a government bond with a guaranteed negative return to maturity. You still get a positive credit spread after all. Also, if you think we are going to experience deflation in the Eurozone, a zero return in nominal terms still means a positive real return, either way, you are better off – crazy I know, but true!”
Chad finishes and sits down, smiling even more broadly than before, supressing the urge to punch the air.
Now, I hasten to point out that all of the above is total (and poorly written) fiction, but we may be getting closer to the point where such conversations are possible.
In his daily note to investors on 4th Feb, Jim Reid at Deutsche bank pointed out that Nestlé’s EUR 2016 bond closed at a yield of negative 0.002%.
The market is essentially sending out an unprecedented pricing signal to highly rated corporate issuers. It’s saying “we will not demand a nominal positive return for lending you money.”
The immediate consequence of this is a further reduction in potential funding costs for short term debt, particularly for investment grade companies. This could lead to yet another round of financing cost efficiencies. Additionally, we may even see zero yield short term corporate bonds being issued for the first time – a brave new world indeed.