Participants in the roundtable, which took place in December, were:
Sandeep Dhawan, head of dollar funding, EIB, Luxembourg
Stefan Goebel, head of treasury, Rentenbank, Frankfurt
Jens Hellerup, deputy head of funding and investor relations, NIB, Helsinki
Paul Lynch, managing director, US syndicate, RBC Capital Markets
Mike Manning, executive director, capital markets division, Ontario Financing Authority
Jigme Shingsar, managing director, debt capital markets, RBC Capital Markets
Petra Wehlert, head of new issues, KfW, Frankfurt
Moderator: Philip Moore, contributing editor, EuroWeek
EUROWEEK: Lets start by looking back to March, and at KfWs $4bn five year benchmark which was priced that month at 95bp over swaps. Did that transaction represent a high watermark for spreads in the SSA market in dollars?
Wehlert, KfW: KfWs achievements in the dollar market in 2009 were quite noteworthy. It was the third year in a row that we were able to extend the range of maturities in dollars, and we were even able to issue a 10 year bond.
Overall, we saw many more investors in the dollar market than in previous years. One of the lessons weve drawn from the last year is that KfW is always supported by its investors, albeit with a certain price concession at times. The high swap spread of our $4bn five year global attracted a lot of US investors who have become increasingly familiar with KfW since then. They have supported us much more consistently since that time than they did before.
The high spread gave us access to liquidity which is crucial during a crisis. It also ensured an outstanding performance for investors. It is important to bear in mind that the dollar-euro basis swap at the time was still around 60bp, which helped us to price in the context of the market.
Lynch, RBC: One of the main themes of 2009 was that we were able to engage the US real money investors in a meaningful way. That was primarily because spreads had widened out versus other products creating attractive relative value opportunities. Supranationals and sovereigns were almost forced to adjust their pricing in dollars because of the levels at which government-guaranteed paper was trading.
So it was a very good year for engaging the US customer base, but that was based on how attractive the market was from a pricing perspective. I agree that KfWs five year deal in March was an important turning point because so many of the accounts that were attracted by the pricing of swaps plus 95bp remained engaged in the SSA market for the rest of the year. Even though spreads have narrowed so much since then, it looks as though investors will remain engaged when January comes round.
Dhawan, EIB: I would characterise the last 12 months as having been reasonably challenging.
At the start of 2009 it was not entirely clear to us how we were going to be able to raise our rather large funding requirement for the year given the state of the markets. At the time, much of our core investor base was certainly not buying. More often than not, accounts were selling their holdings for a variety of reasons. Spreads were very volatile and there was little indication as to when the bottom would be reached, or indeed when investors would start to conclude that pricing levels in the SSA market had become too attractive to miss as a buying opportunity.
The underlying swap and rates markets were also extremely fragile. Dealer counterparts were mostly distracted; balance sheets were by and large absent; underwriting capabilities were diminished substantially. Given that backdrop, it seemed to us that it would be very challenging to raise the kind of volumes we were looking to raise in 2009.
But the year got off to a reasonably solid start in terms of funding volumes. Once the exercise gathered pace, not just for us but also for other issuers in our sector, some of the concerns that we had in the early weeks of 2009 seemed to dissipate and funding got back on track.
As far as individual currency markets are concerned, much of the underlying market action was dollar-based, whether in rates, swaps or basis swap markets. Other key influences included event risk, the unorthodoxies being deployed by the Fed, and US macroeconomic data.
At the same time, new products were being introduced in the form of various government-guaranteed bonds that were going through a process of price discovery. That process began at the cheap end of the scale, which meant that there was a new product in our space which was cheaper than even our historically widest trading levels.
EUROWEEK: Ontario kicked off its dollar funding programme in January with a $2bn three year benchmark which was its largest dollar global since 1998. Although Ontario has been in the US dollar market for many years, did you aim to increase the share of dollar issuance in your overall funding programme in 2009?
Manning, Ontario Financing Authority: Yes. Our experience in the US dollar market was very positive in 2009. Weve been a regular issuer in the dollar sector since 1991, which means we have built up good name recognition in the market.
In calendar 2009, we issued $13.75bn in US dollars. This fiscal year, US dollars have accounted for about 30% of our total borrowing, compared with 23% in the previous fiscal year and 14% in 2007-2008. That is a higher figure, given that our total funding requirement has also risen this fiscal year to $42.6bn, compared with $28.7bn last year.
The big story for us in the US dollar market in 2009 was that we were able to increase our standard issuance size. In 2008 our standard issuance size was $1bn -$1.5bn, whereas in 2009 we were able to increase that to between $2bn and $4bn. As well as being able to double our standard issuance size, our benchmark dollar deals in 2009 were consistently oversubscribed, so the size of our books in 2009 were well over double those we had seen in the previous year.
EUROWEEK: What was the share of dollar funding in borrowers overall issuance in 2009, and how did that compare with previous years?
Dhawan, EIB: On average, EIB tends to fund 80%-85% of its programme in the three largest capital markets in the world, which are euros, sterling and US dollars. Dollars and euros are the main contributors, usually accounting for roughly 30%-35% of the annual total.
But these percentages are influenced by market circumstances. So in 2008, dollars accounted for 43% of the funding programme, whereas in 2009 they were about 26%. In 2009 euros accounted for over 50%, which is unusually high.
Wehlert, KfW: $34.6bn of our funding was in dollars in 2009, of which $21bn was in our US dollar global programme, through six transactions and one reopening. The remainder was split between larger floaters, Eurodollar transactions, and structured bonds off our US MTN and EMTN programmes.
In terms of aggregate distribution of our dollar bonds in 2009, 50% was to the US, up from 24%. Asia was 24%, compared with 29%, and Europe was 22%, down from 42%.
EUROWEEK: Rentenbanks $2.25bn five year deal in September was its first dollar benchmark since May 2008. What was the background to that transaction?
Goebel, Rentenbank: We had been absent from the dollar benchmark market for a while mainly for duration reasons. In the first half of the year we focused on longer maturities and our issuance had an average life in excess of seven years. We did seven and five year euro benchmarks, and a seven year Swiss franc issue. We also did numerous transactions in the domestic private placement market in euros and in registered format which had a maturity in some cases of 15 years.
For most of the first half of the year, US dollar investors were looking for short-dated paper. Their initial focus was on two and three year deals and then they started moving slowly into the five year space. But we found that the premium for US dollar issuance remained very high in the first half of 2009 because there had been some secondary market selling which had pushed spreads out too far in the dollar market. So we didnt feel that the first half of the year was the right time for us to position ourselves in that market.
That changed significantly as we went into the third quarter of the year. Although we may have been quite late into the US dollar market compared with some other SSA issuers we felt that the timing was right because by then it was clear that there was plenty of real money investor appetite in the US.
EUROWEEK: NIB also has a relatively modest funding requirement. How have dollars fitted into your financing strategy in the last year?
Hellerup, NIB: In 2008 we did three benchmarks in dollars. In 2009 we only did one, which was a $1bn global five year transaction in September.
That meant that dollars only accounted for 34% of our total funding in 2009, which was about $4.1bn. That is the lowest share ever since we started issuing dollar benchmarks. In 2008, dollars accounted for almost 70%.
Like Rentenbank, we were looking for duration in the first half of 2009. It would have been very expensive to access duration in the dollar market in the first half. Besides, as about 60% of our lending is in euros we always intended to issue a euro benchmark when conditions were right, and we had the chance to do so in early 2009 at roughly the same price that we would have issued at in the dollar market.
EUROWEEK: Going back to the strength of US demand for Ontario, how much of this is a reflection of economic fundamentals?
Manning, Ontario Financing Authority: The Province of Ontario gives investors a means of gaining exposure to Canada, which is a rare issuer outside the domestic market. Ontario accounts for about 40% of the countrys GDP and population, and offers a positive margin to investors versus Canada and EDC. Canadian entities continue to look attractive to investors, due to its strong fiscal position, its robust housing market and its sound mortgage and banking systems.
EUROWEEK: EIBs $5bn five year trade in September was its largest ever in the dollar market. Was this a barometer of the strength of US real money demand for SSAs?
Dhawan, EIB: We have had some very notable successes in the dollar market these past months, but maybe more was made of the $5bn figure than it should. We have issued several $4bn-$4.5bn benchmarks in the past. Given the size of the order books we have had, there have been plenty of opportunities for us to print $5bn trades. But weve shied away from printing a $5bn trade for a variety of reasons perceptions around the $5bn number suggest that the size is seen as rather large and unwieldy, and trading in the aftermarket of some of the $5bn trades printed by others did not always inspire confidence.
EUROWEEK: Some 125 accounts participated in that trade, which is the largest number ever for EIB in a dollar trade. Is the structure of your US dollar investor base changing?
Dhawan, EIB: One clear theme that we saw in the dollar market in 2009 was that our books became more granular. We saw plenty of small tickets from a variety of investors ranging from retail to corporates and regional banks. That helped to give the book a little more of the spine and evenness that books in this sector may have lacked in the past. We used to be more dependent on a handful of very large orders. Distribution in 2009 was more evenly spread in terms of order sizes than in previous years.
Manning, Ontario Financing Authority: The higher liquidity in our issues over the last year has attracted a much more granular investor base. Our distribution has been more US-driven than in the past and we are seeing many more real money investors coming into our books, including pension funds, insurance companies and asset managers.
We have a long-standing investor base in the US, but we have also seen new accounts coming in. Sometimes they are much smaller investors than we have been used to in the past, which is fine. These days were typically seeing 100-200 investors involved in our US dollar transactions, which is a substantial increase from a few years ago.
Shingsar, RBC: 2009 represented an absolute high relative to the last decade in terms of penetration of the US investor base. As Paul said, some of that has almost been achieved by default because spreads were pushed to very cheap levels by all the competing supply.
But what was especially impressive was that we were able to continue rallying throughout what was a record year in terms of supply for the SSA sector. The big question is, will the US investor base continue to remain engaged as these issues come at tighter and tighter levels and the answer so far has been yes. That is obviously something that will need to be watched going forward, but we are optimistic that it will continue to be the case. There are relative value considerations compared to where GSEs are trading. But there is also the fact that outright supply of GSE and similar products is down. So there are plenty of compelling reasons for US investors to stay engaged with SSA product, and for issuers to look as much like a substitute for GSEs as possible.
Wehlert, KfW: Initially, we saw an increase in demand for our US dollar benchmarks from credit investors in 2009 because spreads on the triple-A product became very interesting for them.
Given the overall market development, with reduced issuance from GSEs, we see rates investors increasingly considering our bonds.
EUROWEEK: So was 2009 the year when SSA borrowers finally cracked the US market in terms of investor penetration?
Goebel, Rentenbank: We were extremely happy with the order book for our US dollar global in September. We had strong support from central banks but also from asset managers, which accounted for 48%, and from pension funds, insurance companies and corporates which took 10%. Only 7% went to banks.
Much of the demand from asset managers was from the US, which accounted for the most sizeable orders. Some 60% was placed in the Americas, 22% in Asia and only 15% in Europe.
So the distribution speaks volumes for the new trend we saw in 2009, which is that real money investors in the US are looking at agencies much more favourably. We saw plenty of demand from investors who were new to the Rentenbank credit.
As to whether this demand will be sustainable, many US investors have done a lot of groundwork in terms of analysing and better understanding European agency names. They have gone to great efforts to go through the necessary internal procedures to establish internal credit lines, and they have recognised that this is a product that offers good value. As long as there is less triple-A product available in the domestic market I believe we will continue to see demand for SSA product.
Dhawan, EIB: The real question should be, have SSA borrowers cracked the issue of distribution in the US? That is a different question.
Prima facie, there was more distribution into the US by all issuers in our peer group. But I wouldnt go so far as to declare that we have made deep and longstanding inroads into that domestic franchise quite yet. Although distribution into the US has increased its too early to tell whether that is sustainable or if it was simply the consequence of the spreads that were on offer.
EUROWEEK: Do central banks remain anchor buyers of SSA product in dollars?
Dhawan, EIB: Central banks continue to be staple buyers of this product no doubt about that. But it was certainly the case for EIB that the percentage of distribution into central banks has declined recently, and that was especially true in 2009. This stands to reason because a number of the central banks spent much of the year liquidating their reserve holdings. While we have not yet seen any evidence to suggest that that trend has been aggressively reversed, selling programmes appear to have ceased.
I think that the last 12-16 months have reinforced the belief in the central banking community that having excess reserves is a net positive despite the negative carry and the creation of imbalances. A lot of countries have not been affected as badly by the financial maelstrom as they were in the albeit very different crisis of 1997-98. Most have benefited from having excess reserves.
Furthermore, recent events have at the very least postponed any thoughts of de-dollarisation, and as a consequence the accumulation of reserves is going to continue and be one of the key themes for a large number of central banks over the coming months. This ought to benefit our sector.
Goebel, Rentenbank: We were pleased to see a return of central bank demand when we printed our $2.25bn benchmark. They had not played much of a role in our euro benchmarks which were quite Germany-centric in terms of placement. But 35% of our dollar global was placed with central banks.
Hellerup, NIB: When we did our $1bn benchmark, distribution was very similar to the dollar deals we did before the crisis. Central banks accounted for 58% which is normal for our benchmark dollar transactions.
EUROWEEK: With 58% placed among central banks, did that mean that you saw little in the way of new investors and US institutional demand for your benchmark?
Hellerup, NIB: The figure of 58% refers only to the benchmark issue. Overall the participation of central banks in our funding programme has fallen quite sharply. In 2008 they accounted for a little less than 50%, but in 2009 this was only about 17%. We have seen many more real money investors in our total funding programme, including banks, asset managers and insurance companies.
Wehlert, KfW: Central bank demand was lower in 2009, especially at the start of the year, although it picked up in the second half. Central banks have always been major buyers of our US dollar programme, and will continue to be so. But the main support for us came from asset managers and bank treasuries. Banks are cash rich and we expect more investment into our product from bank treasuries. Going forward, I believe the distribution pattern will be more balanced between all investor types.
Lynch, RBC: The maturity profile in the SSA market means that demand is skewed less towards insurance companies. Borrowers like Ontario, KfW and IADB, which have successfully issued in the 10 year maturity, have been able to generate some demand from insurance companies. But there were only three 10 year deals done by SSA borrowers in the dollar market in 2009, so issuers are inevitably skewing themselves more towards the fund management side.
Banks balance sheets accounted for a large part of investor demand in 2009, particularly in the first half of the year. We have also seen some corporate portfolios come in, especially at the short end of the curve. Additionally, we have seen demand from some US public sector funds that are able to buy foreign names. So it is a much more diversified investor base.
EUROWEEK: Was the $3bn 10 year global launched by KfW in June a breakthrough both for KfW and for the broader SSA market as it was the first 10 year SSA deal since the Lehman collapse?
Wehlert, KfW: Perhaps. There are only small windows when you can do a 10 year benchmark and we were fortunate in that we were able to react quickly and use this window. This was important for our benchmark programme and it was also welcomed by banks and investors, with demand reaching $5.3bn. This emphasises the importance of the dollar market for us. We are the only SSA issuer that is now able to offer investors the full curve of benchmarks in dollars.
EUROWEEK: Ontario was also one of the few SSA borrowers to launch a successful 10 year deal in dollars in 2009. What was the background to your $2bn 2019 benchmark?
Manning, Ontario Financing Authority: We had been hoping for some time to get more duration in the US dollar market. We knew that 10 years was a challenging maturity for the market, but we were happy with the response. We had an order book of $3.3bn, and North American predominantly US investors accounted for 84.5% of distribution. The average ticket size was relatively small, with 85% of the orders for $50m or less.
EUROWEEK: In spite of the successful 10 year deals in 2009, would borrowers agree that a weakness of the US dollar market is that it doesnt offer sufficient duration opportunities?
Dhawan, EIB: That is exactly right. If there is one weakness in the market it is lack of a steady supply of duration. There is no shortage of duration players in the dollar market. But many happen to be based in a single geographical area, which is North America, and peculiarities in that market require one to pay over the odds for incremental duration demand.
Our duration needs are more than adequately met out of the euro and sterling markets. Those markets are characterised by existing or increasing regulation that requires pension funds and insurance companies to match assets and liabilities, which therefore create a systemic demand for duration. This stimulus is thus far absent in the US, and as a consequence, although there is demand for duration from some investors wanting to pick up spread, yield or convexity exposure, there is very little that is liability-driven or institutional in nature.
The consequence is that US investors dont have to buy duration. They can buy when they either have a view on duration or simply stick to buying high grade corporates which offer a very different level of spread to highly rated SSA-type entities.
That creates a hole in the demand spectrum, and coupled with reduced central bank appetite for this maturity creates a bit of a conundrum for those wanting to offer large, liquid, fairly priced issues.
However, every now and then, windows of opportunity open for SSA issuers to print a successful benchmark 10 year deal. Those opportunities tend to arise when the underlying markets seem particularly attractive in yield and spread terms. So if 10 year yields go to 4%, for example, as they did in June, or if 10 year swap spreads are somewhat wider, then underlying market conditions become attractive enough for people to get comfortable with being long duration and buy whatever 10 year product is available.
EUROWEEK: Have there been any other indications this year that the US market is offering more opportunities for duration?
Shingsar, RBC: Its not so much a question of demand. Its more of a mathematical problem. We have an inverted swap-spread curve, which impacts issuers who are focused on Libor valuations. Meanwhile, most investors would expect an upwardly sloping curve in terms of spreads over Treasuries. The two are having trouble intersecting at levels that appeal to both sides.
EUROWEEK: Could the dollar market for SSA issuers extend beyond 10 years?
Manning, Ontario Financing Authority: We might see issuance going longer than 10 years. For us, it would be a little more difficult from a hedging perspective because we generally aim to hedge our foreign exchange exposure back into Canadian dollars. The longer the maturity, the more difficult and expensive hedging becomes.
EUROWEEK: The favourable basis swap was a powerful driver of supply in dollars from a range of SSA borrowers in 2009. Transactions from borrowers such as Germany, for example, were clearly arbitrage-driven. But are issuers from the SSA sector with heavy annual funding requirements prepared to sacrifice some of the economics in exchange for the long term strategic benefits of tapping this market?
Dhawan, EIB: The basis swap is not a driver of our issuance in the major currencies. We have no choice but to be present in the three largest capital markets on a reasonably consistent basis. Do we look at basis swaps? Of course we do, because, for instance, we borrow more in dollars than we lend. Some of the proceeds therefore need to be swapped back into the currencies required for lending.
Does that mean that the timing or volume of our issuance is determined by the basis swap market? Absolutely not. By definition that can not be possible.
EUROWEEK: How important is the basis swap to NIB, given that a fair amount of your lending is in dollars?
Hellerup, NIB: Some 60% of our lending is in euros, with 20% in Nordic currencies and only 20% in dollars. So the basis swap is very important to us. That said, we have been issuing dollar benchmarks now every year since 2002, so we are fully committed to the market.
EUROWEEK: In the case of Ontario, how has pricing in the US dollar market compared with the levels you pay in the domestic market?
Manning, Ontario Financing Authority: We definitely see US dollars as a core market for us, and we want to make sure we remain a regular issuer and develop a yield curve in the market. We also look at pricing in the context of size, and in many instances US dollars may appear more expensive, but when you factor in the adjustments for larger size, the cost differential is much less significant.
EUROWEEK: Rentenbank must have been delighted with the pricing it achieved for its three year dollar benchmark in September, which came at 3bp over swaps?
Goebel, Rentenbank: You can never claim to have achieved perfect pricing but we were able to attract investors by offering a Libor-plus spread and therefore leave some potential for performance on the table for investors. At the same time if you look at the all-in Euribor pricing level for Rentenbank it was the best we have achieved on any benchmark transaction in US dollars or euros.
We were able to tighten from the initial guidance of plus 5p to plus 3bp, because the order book reached close to $3bn. The aftermarket performance speaks volumes about the transaction, which is now trading sub-dollar Libor and on a mid-swaps basis it has tightened by about 5bp. So I think its fair to say that we returned to the dollar market in style, which was important for us as we had been away from the dollar screens for some time.
Hellerup, NIB: I should also add that we were delighted with the pricing level of 5bp over mid-swaps, which equated to 37bp over Treasuries, that we achieved with our benchmark dollar deal in September. Timing was critical in 2009 because as you were saying earlier, pricing for five year dollars in the SSA sector reached almost 100bp in the spring.
It has been a real roller-coaster in terms of pricing over the last 12-18 months. In 2007 we were pricing dollar benchmarks as low as minus 20bp. Then the sector moved out to plus 80bp or plus 90bp and now were roughly flat again. Getting back to minus 20bp may be difficult but we have certainly come a long way since the start of 2009.
EUROWEEK: Does a borrower like NIB benefits from relative scarcity value in the dollar market?
Hellerup, NIB: Yes. A number of accounts have been telling us that they are starting to get quite full up on some of the bigger SSA borrowers. But there is always a discussion about which is more important scarcity value or the ability to provide high levels of liquidity with $5bn benchmarks.
EUROWEEK: With spreads having fallen so far since March, what are investors telling issuers today about what theyre prepared to pay? Will they be prepared to pay even tighter spreads in 2010?
Wehlert, KfW: Good question. The credit curve is very steep at the moment. At the shorter end of the curve levels are relatively tight at the moment but nevertheless investors may still be keen to buy as KfW is still offering a decent pick-up versus agencies. And traditionally we have priced around their levels, so there may be a reason to believe there is further room for performance.
EUROWEEK: Would a borrower like KfW be prepared to pay up a little bit more if necessary, just to tap into the depth and liquidity of the US investor base?
Wehlert, KfW: In 2009 we had to fund about Eu75bn equivalent. With a borrowing programme of that size we clearly need to fund in euros and dollars. Traditionally the dollar programme has been a bit cheaper than the euro programme, but we need both, and we are fully committed to the dollar market.
That is also applicable at the longer end of the curve, where we may face a situation in which a dollar benchmark is more expensive than a euro deal. Nevertheless, we would not exclude issuing if that is the case, just because we need a diverse range of products to offer investors.
Lynch, RBC: One of the lessons that borrowers learned over the last year to 18 months is that it is essential to have as broad a reach as possible, and that it is imprudent to target your issuance purely at a narrow audience of investors such as central banks. When central banks had to tighten their belts a little and found that they did not have as much money to put to work as they did previously, borrowers needed to reach out to find a new investor base or to investors they hadnt used for some. From that standpoint there is probably an argument for following a more strategic issuance policy. But that will vary depending on the size of issuers borrowing programmes.
Shingsar, RBC: Dollars have typically been a more cost-effective market for what feels like at least 90% of the time that the euro market has been in existence. That cost advantage currently drops off the further you go down the curve.
For Canadian borrowers the picture is a little different. For them, there is a cost associated with issuing in dollars.
The bottom line is that dollars represent a strategic market for most large issuers. But I would agree that how they use the market, in the sense of whether or not they have to pay up to access the market, depends on factors such as the size of their borrowing needs, capacity in other markets and so on.
The euro basis is wide at the moment, especially at the short end of the curve, and some issuers may be taking advantage of that. But if youre a borrower like KfW or EIB, dollar issuance will remain a fundamental part of the overall funding programme. Their allocation between dollars, sterling and euros will vary depending on where the pricing advantage as well as where the demand is.
EUROWEEK: Are there are other knock-on benefits of issuing successfully in dollars? Can a successful dollar benchmark lead to a borrowers spreads narrowing in other currencies?
Manning, Ontario Financing Authority: There is a positive effect in the sense that if you do a large, oversubscribed benchmark in US dollars, investors will expect there to be less supply in the domestic market. Canadian dollars are of course our core currency but issuing in US dollars, euros and other currencies definitely helps to relieve pressure on our domestic funding programme.
Shingsar, RBC: I agree that that has certainly been true for Canadian issuers. When they have done successful deals offshore that has had a beneficial impact on their spreads in the domestic market. So there is some validity in the notion of demonstrating access to liquidity away from your core investor base.
EUROWEEK: Would you expect to see new SSA names tapping the dollar market in 2010?
Shingsar, RBC: Supply in the SSA sector away from pure government supply is moderating after a significant uptick in 2009. There will certainly be a continuous increase in terms of governments requirements and that could spill over into the dollar market in 2010. But that shouldnt be a problem as there is plenty of capacity for another benchmark issue from a borrower like Germany or from another European name that is a less frequent issuer in dollars.
Lynch, RBC: Another development we saw last year, which goes back to what we were saying earlier about reaching a broader investor audience, is that some borrowers have added 144A language to their programmes or adopt a global programme. I think we will see more SSA borrowers doing this, which will be another key way of reaching out to a broader investor base.
Wehlert, KfW: Because the basis swap is so attractive for European borrowers, I would expect to see more issuance from European SSAs next year. So competition will definitely be more intense. Weve spoken a lot about demand, but I think there will be more sovereigns from Europe to offer dollar products in 2010. Many have a very large funding requirement so I would expect those that look at the market from an opportunistic perspective to keep an eye on opportunities in the dollar market. That in turn may put some more pressure on the basis swap.
EUROWEEK: With Greece having been recently downgraded into triple-B territory and continued noise over the triple-A ratings of a sovereign like the UK, how sensitive to ratings are US investors?
Lynch, RBC: I think its less a case of ratings sensitivity and more an issue of being sensitive to relative value. We certainly had a period where there were certain accounts that werent looking at Spain, for example, or at government-related entities there.
But there has definitely been a bid for some of the implicit or non-guaranteed names because they do offer a little more spread. So its less an issue of ratings than of investors doing their own credit work and making their own decisions.
EUROWEEK: In November, Ontario issued a $4bn three year global in the US market in the form of a dual-tranche fixed and floating trade. What was the rationale behind this transaction?
Manning, Ontario Financing Authority: I am not sure that the dual tranche structure could be termed innovative, although it is somewhat different from our traditional approach. We were exploring the idea of a US dollar FRN at the same time that we were also looking at a fixed rate deal. While we were weighing up how we could respond to both of these opportunities it was suggested to us that one option would be to do a dual-tranche deal and we simply moved ahead with this idea. Dual-tranche issues have been common in the Canadian provincial market for over a year now, and we have become comfortable with the structure. I expect that we will explore this option again in the US market.
EUROWEEK: How if at all will the tightening of monetary policy throughout the world impact SSA borrowers in 2010 and beyond?
Wehlert, KfW: In general we believe that the end of the quantitative easing with regard to GSE buybacks is already priced in and will therefore not have a dramatic influence on relative performance and pricing. We think that the overall development of the GSEs is probably more important than the end of the buyback programme. However, as to a general tightening policy there are other factors to consider. For example, the withdrawal of cash from the system through reverse repos should have a negative impact on the cash balance of the banks. In that context, we would expect their participation to decline.
Rate hikes will have an influence on the curve. In addition, a lot will depend on the development of expectations regarding inflation.
All these aspects remain uncertain at this stage, but they will ultimately determine whether it will be easier to issue in short or long term maturities. However, we would not expect a general tightening to lead to a shortage of cash in the US dollar market.
Lynch, RBC: When the Fed announced that it was going to buy fewer agencies the market reacted, but I agree that the end of the buyback programme is now reflected in pricing in the market. But I recognise that there are a variety of views on this, with some people believing well see some spread widening in the new year.
Shingsar, RBC: There are two things to consider here. First, there is the credit profile of the GSEs and how they will look in the future, which is still open to debate. But in the meantime the supply picture for the GSEs remains pretty light and if you were to believe some of the talk about where they ultimately want to be, they are all going to end up as smaller institutions. If thats the case, quantitative easing just took the pressure off the market at a time when there was liquidation by central banks. So our strategists view is that the end of quantitative easing should not have a negative impact on GSE spreads.
Dhawan, EIB: Clearly, the more money there is in the system, the more buyers there are and the easier it is to sell your paper and complete your funding.
Most of the excess liquidity currently seems to reside within the banking system. Certainly in the case of EIB, bank treasuries have become a large part of the investor base in dollars as well as in euros. This is a completely new investor base for us. It didnt exist before, because EIB has generally been a sub-Libor issuer throughout its history, which did not suit bank treasuries.
Now, as spreads start to come in, and levels dip below Libor in some maturities, and as some of the government-induced liquidity is withdrawn, it will be interesting to see how the banking community will react. Logically, their participation in this sector ought to diminish.
However, there is a new dynamic coming through, which is that many governments are going to introduce liquidity buffers sooner rather than later that banks need to hold over and above what they have historically held. So far the countries that have announced what constitutes these liquidity buffers have indicated that government bonds and very highly rated entities such as supranationals will be required to make up some part of these buffers. So the regulatory environment could dictate that banks hold high levels of liquidity and that they invest part of this liquidity in government and supranational bonds. Hence I dont think this source of demand will disappear entirely from the sector. Its an additional participant in the sector and I think it will remain in the sector albeit not to the extent it did this year.
Furthermore, as I said earlier, as the crisis abates and as fire-fighting diminishes, central banks should start to replenish their reserves, so I imagine the percentage take-up by those buyers will increase, which is another positive factor for the sector going forward.
Eventually, perhaps towards the latter part of the year if we find ourselves in a higher rate environment, this ought to encourage coupon and yield-focused investors.
So there are certain positive influences going forward, although in the short term I think markets will remain rather fragile. Every now and then, as we have seen recently, event risk causes a large degree of volatility. So the beginning of 2010 will continue to be challenging, both in terms of volatility and the dampening effects from the anticipation of higher rates.
EUROWEEK: Another potentially big macro issue for 2010 is the projected weakness in the dollar. How would protracted dollar weakness impact the market for SSA issuance in US dollars?
Shingsar, RBC: The dollar remains the worlds most important reserve currency and central banks are still the most important component of demand for SSA product. US domestic investors will obviously continue to buy dollars anyway. So the main factor that could influence overall demand levels, and therefore clearing prices, is continued diversification away from the dollar a trend that began well before the current crisis.
Perversely, as the dollar sells off investors often react by seeing that as an opportunity to buy dollars. So I dont think there is much danger of a uni-directional impact of dollar weakness.
As some of the central banks or official institutions continue to diversify we may end up seeing a little more price sensitivity than weve been used to seeing from those accounts. It will be interesting to see what the impact of that is on distribution in the future. Perhaps one consequence will be that there is less risk than in the past of the US investor base being crowded out.
But I think the overall story going into this year is still very good. We got through a year very successfully in which peoples borrowing needs shot up very dramatically and at a time when market conditions were difficult and liquidity was poor. Liquidity in secondary markets has improved significantly. So were going into 2010 from a pretty solid base.
Wehlert, KfW: Our approach worked well in 2009, but we start the new year in a completely different environment. Confidence has returned to the market, but there are still some risk factors in the background. This means we have to maintain a conservative strategy, but not to the same extent as in 2009.
Additionally, we have to look at the overall yield environment and on the influence of investor behaviour. Given that many investors believe that rates may start to rise in the second half of 2010, longer duration issues may achieve better placing early in the year. Ten year transactions are the most important in both the euro and the dollar sectors so it will certainly be one of our goals to issue another 10 year benchmark in dollars if market conditions permit us to do so.
Besides, spreads are quite interesting in the current environment, so you can expect KfW to be a significant market participant in the first half of 2010.
Manning, Ontario Financing Authority: We expect our funding requirement in 2010 to go down slightly to $39.7bn, compared with $42.6bn in 2009. The US dollar market will continue to be an important part of our funding programme in 2010. We are targeting about 35%-50% of our total funding to be in international markets, and to date about two-thirds of our non-Canadian dollar funding has been in US dollars.
Shingsar, RBC: Another question for 2010 is that there is usually a lot of front-loading of SSA borrowers funding programmes anyway. In 2009 people front-loaded even more than usual because of the near-panic situation we had at the start of the year. As it turned out, that was when money was most expensive. So while you would never advocate that borrowers run the risk of falling behind on their programmes, it will be interesting to see what their attitudes towards front-loading are in 2010.
EUROWEEK: For borrowers with large funding programmes, is front-loading relevant?
Wehlert, KfW: In 2009 we front-loaded a lot, which was a reflection of the crisis. In general I would expect us to pursue a similar strategy in 2010, mainly because we have a large borrowing requirement. That means we need to do a lot in the first half of the year, although maybe not necessarily to the same extent as last year.
Looking at it from the perspective of the investors I would expect them to be keen to buy at the short end of the curve because if you expect rising rates you wouldnt expect them to buy at the longer end of the curve.
Dhawan, EIB: The volume of EIBs funding clearly shapes its strategy, rather than the other way round. The volume of our funding means that we will be a regular issuer that will need to be present in all large currency markets.
The question then is, with such a large funding requirement can you front-load a proportion of your borrowing? Institutions such as EIB and its peers do tend to be biased toward doing more earlier when possible because they are by nature conservative. And when you are faced with a funding requirement of Eu80bn as we are, it helps to know that youve got 55% or 65% completed prior to the summer break so youre not hostage to the size of your funding volume in the second half of the year. And in any event, from a funding windows perspective, the second half of the year is always shorter than the first.
The Annual RBC Capital Markets US Dollar SSA Roundtable
The dollar market for sovereign, supranational and agency (SSA) borrowers hit the ground running at the start of 2009, with borrowers such as SFEF and the World Bank issuing record-breaking $6bn benchmarks early in the year. Perhaps more important than the size of individual deals in 2009 were the trends in the distribution of dollar benchmarks issued after the first quarter. These featured a notable rise in the participation of US real money accounts in the primary market for SSAs, suggesting that a new and durable investor base has now emerged for public sector borrowers eager to maximise the diversity of their funding sources. In the annual EuroWeek/RBC Capital Markets US Dollar SSA Roundtable, a number of SSA borrowers shared their thoughts on key trends in the market.
Participants in the roundtable, which took place in December, were: