The sterling market is the latest non-core currency bond sector revelation, highlighting how much supranational and agency issuers have valued funding diversification amid heightened worries over the Eurozone sovereign crisis.
Annual non-UK SSA sterling issuance increased from £13.37bn in 2010 to £21.03bn in 2011. And the trend has continued into 2012, with some £8.45bn of deals launched by March 9.
Gilt buyers have seen in non-UK SSA paper a fitting replacement for falling UK government bond supply. "There has been huge pent-up demand waiting for new investment since December last year," says Kentaro Kiso, head of global MTN syndicate and public sector at Barclays in London. New Gilt issuance in February and March is estimated to be £27bn some £4bn short of redemptions in the same period.
Non-UK SSA paper also offers investors eye-catching returns over Gilts, which have recently offered as little as 1.5% returns for three year paper. Non-UK public sector borrowers have offered up to 100bp above that.
"A Gilt surrogate will always be valued," says Bill Northfield, head of SSA origination at Deutsche Bank in London. "With the Bank of England buying Gilts for its QE programme and rates rallying, Gilt returns have become less attractive than they were one or two years ago."
Two of the most impressive deals so far this year, one from Caisse dAmortissement de la Dette Sociale (Cades) and the other by the World Bank, coincided with the Bank of Englands February 9 announcement to keep rates at 0.5% and purchase a further £50bn of Gilts as part of its quantitative easing programme. "If youre at least a strong double-A agency, you have access to a deep sterling market right now up to three or four years," says Kiso.
Cades dazzled the market with its £1bn three year FRN, which was launched at just £250m. The deals unexpected success was such that bankers were forced to consider whether the traditional definition of a benchmark deal as one of £250m notional was still sufficient.
Investors have been seeking high yielding sterling paper to the extent that they are less concerned that those bonds would be eligibile as liquidity buffers. As in Cadess case, "banks are taking a discretional interpretation of which paper will be eligible for FSA and Basel III buffer buckets," says Kiso. "Investors will buy paper if its from a strong, liquid credit."
The World Bank also issued a sensational transaction, attracting £900m for an £800m three year FRN only days before the Cades trade. Investors enthusiastic response allowed the borrower to price the tightest supranational and agency sterling deal of the year so far at 42bp over the 5% 2014 Gilt.
Most market participants thought the Australian dollar market was done for by the end of last year. The Australian Prudential Regulatory Authoritys (Apra) February 2011 decision to exclude foreign sovereign, supranational and agency paper from qualifying as Level 1 or Level 2 liquid assets prompted the first fall in Kangaroo activity. With domestic bank treasuries no longer buying foreign SSA bonds, average deal size dropped from around A$1bn to A$300m-A$500m.
However, it was the escalating Eurozone sovereign crisis later in the summer that knocked out the already weakened Kangaroo market. Australian dollar investors panicked to the point where they shunned foreign SSA names no matter how strong the rating or underlying sovereign relationship. Even top rated borrowers spreads blew out the European Investment Banks nine and 10 year lines widened by 175bp throughout 2011 while KfWs 2021s gapped out by an unlikely 100bp."We refrained from issuing not because our levels widened that happened in various other markets as well but because our spreads in Australian dollars were very uncompetitive in comparison to other large currency markets," says Richard van Blerk, senior funding officer, Americas and Asia Pacific, at the European Investment Bank (EIB) in Luxembourg.
However, core markets performance this year and the European Central Banks long term refinancing operations (LTROs) have restored investor confidence and helped re-establish a two-way flow in secondary markets.
"There was speculation around the EIB being downgraded and about it being used as a bail-out vehicle for Europe," says Alex Caridia, head of SSA DCM at RBC Capital Markets in London. "Look at it this year. It has done over 50% of its funding and has managed to achieve both volume and duration in the euro, sterling and US dollar markets without any problems. Australian investors see this and the spreads they can buy at now really represent good value."
"Last May it seemed possible Australian dollar investors would never buy Europe again," adds Northfield. "But this year, they realised that European names priced euro transactions containing notable Asian central bank participation, and this strong statement gave them confidence to return to the table."
Even domestic investors, which were hit hardest by the Apra announcements, have participated in Kangaroo trades this year. Australian accounts placed half the orders for KfWs A$500m tap of its 2018s at the beginning of February and drove Rentenbanks A$250m 5.5% eight year note priced on March 1.
"Domestic banks continue to look for liquid bonds from high quality, responsible issuers this is why KfW is still well placed in this market," says Petra Wehlert, head of funding at KfW in Frankfurt. "In addition this year we have monitored increasing demand from domestic asset managers."
Normalising spreads and a favourable 25bp move in the basis swap convinced KfW and the EIB to resume their Kangaroo programmes in January. The unprecedented yields they offered aroused investor interest. "Spreads in Australia have been slower [than other markets] to contract again which has given buyers the opportunity to lock in decent returns," says Caridia.
These successful transactions tightened secondary spreads further, to the point where the World Bank, which had performed better than its Eurozone peers in the last six months, could return to the market without paying up to satisfy investors. Its jumbo A$1.05bn dual trancher priced in February showed that demand was not limited to higher yielding trades from Eurozone names.
A raft of issuers, including the Asian Development Bank, International Finance Corp and Rentenbank followed thereafter on the back of the markets restored buoyancy. The sector also welcomed new names. FMS Wertmanagement issued a A$500m no-grow debut transaction in early March, which was increased from A$250m, while L-Bank and Municipality Finance were looking to meet Australian dollar investors later in the month. L-Bank has not tapped this sector in five years.
Market participants believe this comeback has strong foundations. "Issuers wouldnt be coming back to the market if there were questions about demand," says Caridia. "These bonds are not being put on dealers books. Theyre all going to investors."
Demand could grow even further in March when Australian government and semi-government issuers redemptions start to filter through. "We are unlikely to go back to seeing activity peaks like 12-18 months ago, but I envisage a busy first quarter especially compared to the end of last year," says Apoorva Tandon, a director of syndicate at Australia and New Zealand Banking Group in Sydney.
A new era for Kanga?
The Kangaroo market for SSAs will also benefit from investors wanting alternatives to sovereign and semi-state paper.
"Even if Apra definitely rules out foreign SSAs from liquid level 1 and 2 assets, domestic investors will still want to diversify away from Australian government bonds," says Kiso. "The likes of KfW, Rentenbank, the World Bank and other high grade names would still return to this market and they would still find demand both from domestic and international investors."Meanwhile SSA borrowers have selected the sector as a potential future benchmark market after its record-breaking performance at the beginning of last year. "In some cases, non-core markets offer more competitive funding, but the Australian dollar market showed the promise of being a more mature and stable funding market," says EIBs van Blerk.
Kiso at Barclays agrees. "Issuers have spent time fostering this market last year, organising roadshows, meeting investors, setting up dealer groups, having banks report secondary levels on a monthly basis etc," he says. "It wasnt a cheap investment. And they also promised investors they would be constant programmatic Australian dollar issuers, instead of being optimistic ones."
The Kangaroo market also continues to provide tenor and volume flexibility options which are not always obvious in the euro and US dollar sectors. "Some issuers are willing to pay up a little bit," says Northfield. "They cannot achieve duration in many markets and the Australian dollar sector allows them to issue smaller trades."
Kauri bonds on the rise
The New Zealand dollar market has gathered speed this year with Export Development Canada, KfW, the Nordic Investment Bank and the World Bank all having issued Kauri bonds totalling NZ$834.11m by early March. Issuance volumes in the same period last year had reached only NZ$96.63m.
New Zealand investors, like their Australian and Norwegian counterparts, are keen on buying top rated SSA names to replace rare and low yielding government bond supply. Borrowers, on the other hand, see this market as a unique diversification opportunity since domestic investors only buy New Zealand dollar paper.
"We are keen on tapping the domestic investor base which buys us mainly in Kauri format," said Jens Hellerup, head of funding at NIB after its NZ$200m 4.125% five year note was priced in early March. "Diversification in funding is very important for us."
And foreign SSA flow is showing no sign of slowing up. "Well probably show our face in this market later on," says Leopold Olma, head of funding at Rentenbank. "The year is still young."
Nokkie market matures
The Norwegian krone market is one of the non-core sectors that has benefited from the Eurozone sovereign crisis the most. Demand from domestic investors seeking alternatives to rare government bond supply as well as international buyers, such as central banks, building exposures to strong non-core currencies, fuelled the markets growth last year.
"This used to be largely a retail market which is now developing to be a combined sector of retail and institutional accounts," says KfWs Wehlert.
Foreign supranationals and agencies seeking dependable funding diversification are key to the markets development. Annual agency issuance volumes of Nkr1.5bn in 2005 grew to Nkr31.8bn in 2009, totalled Nkr42.0bn in 2010 and reached a record high of Nkr63.97bn in 2011. Supply had reached a promising Nkr13.28bn by March 9 this year.
Norways commodity-based currency and its strong economy make the krone sector a beacon of stability. "As long as there will be geopolitical tensions around the world, investors will always want to invest in Norwegian kroner for oil play and currency diversification," says Kiso.
However, other market participants think this Nordic markets time in the sun will always be limited and dependent on problems elsewhere. "Buyers want to invest in countries away from the Eurozone," says Rentebanks Olma. "But if markets in Europe settle down, issuance in Nordic currencies will peak off too."
Unfavourable basis and cross-currency swaps and the combination of depressingly low mid-swap rates and yield-hungry investors have made SSA Swiss franc supply challenging over the past 18 months. Issuance opportunities became even more difficult when domestic investors shunned SSA paper after the Eurozone sovereign crisis in the second half of last year.
This year, however, Swiss buyers have started to return to the sector, encouraged by core currency markets promising performances and the European Central Banks interventions. "The LTRO announcements this year have made the black swan event of banks defaulting less likely," says Clemens Durkop, a dealer on Royal Bank of Scotlands Swiss franc syndicate desk in Zurich. "Investors became more confident in Europe overall."
Issuers have also been keen to revisit this market which, similar to the Australian dollar sector, offers duration. "As a project and infrastructure finance institution, we are interested in long term funding to match our maturity profile to our lending," says Richard Teichmeister, head of funding, Europe (excluding euro) and Africa at the EIB. "We are eager to preserve a Swiss franc presence and to maintain secondary market liquidity, but obviously not at any price."
A clutch of SSA borrowers have issued successful transactions this year. Investors have been keen on buying top rated issuers that have been absent for a number of months but have offered far richer spreads compared to a year before.
The EIB and Nederlandse Waterschapsbank re-opened the market with notes paying around 40bp above their pricing curves pre-crisis. The EIB priced a Sfr325m 1.25% seven year trade its largest new franc issue yet at 42bp over mid-swaps, while Nederlandse Waterschapsbank issued a Sfr150m 1% six year note at 40bp over mid-swaps.
SSA borrowers also found traction via rare, short term FRNs sought after by treasury accounts. Oesterreichische Kontrollbank (OKB) priced a Sfr250m two year FRN in early February that was increased from a launch size of just Sfr100m.
Even Kommuninvests Sfr150m 1.23% 10 year note, which came at what a market participant termed an "über-tight" spread of 15bp over mid-swaps, found interest. The borrower had not tapped this market in three years.
With Swiss investors back in the game French names have returned to the market. Caisse de Refinancement de lHabitat issued a jumbo Sfr650m dual tranche covered bond in February, which offered irresistible spreads of 90bp over mid-swaps for its seven year clip and 105bp over for its 12 year tranche.However, the price at which the top SSA borrowers would have to pay to satisfy Swiss investors is still too high. "We do at times pay up versus our euro levels if necessary," says KfWs Wehlert. "But issuing in Swiss francs is extremely expensive for us and we have no natural need for this currency." A Swiss franc KfW deal meeting the borrowers funding targets would have to be priced in the double digit sub-Libor area, a level that Swiss investors are not prepared to accept.