"These are unique times." On that, everybody is agreed. The European Investment Banks head of dollar funding, Sandeep Dhawan, hit the nail on the head when trying to explain how the equivalent of World War III had been been avoided in the sovereign, supranational and agency bond market in the first full week of this year.
Recriminations seemed inevitable when the EIB announced that it would be launching a 10 year dollar benchmark that week. KfW Bankengruppe, the German development bank, had hoped that its declaration of similar intent the previous week would, for once, allow it first-mover advantage at the start of the year, but its hopes were dashed.
As if this were not competition enough, Fannie Mae and Freddie Mac were launching 10 year dollar Benchmark and Reference Notes, respectively.
Did those involved really imagine that the $10bn-plus of paper could be absorbed?
Had KfWs leads, JP Morgan, Merrill Lynch and UBS, and EIBs bookrunners, Citigroup, Goldman Sachs and Morgan Stanley, failed to find a home for the unprecedented issuance, there surely would have been hell to pay particularly for the latter trio.
But an astonishing level of demand enabled all four issues to reach $3bn, all comfortably subscribed.
"If you had asked me at the beginning of the year whether we should prepare a 10 year dollar transaction at the same time as the EIB and the agencies were doing the same, then I would have had doubts," says Horst Seissinger, head of capital markets at KfW in Frankfurt. "But we had a fantastic environment, with strong demand for 10 year paper, and our issue has had a great performance.
"Our flexibility to react fast in such an environment clearly paid out."
KfW did have to price its bond 1bp back from where it had been expected before the EIB issue hit the screens, but the German agency was able to reach $3bn for the first time in the 10 year part of the dollar market and also place 30% of its bonds with US investors.
At the EIB, Dhawan went further in explaining just what had made the $12bn of supply possible. "Demand for duration is overwhelming," he said. "The predominant sentiment is that the Fed will stay reasonably stable and the 10 year maturity also offers the largest spread.
"These things combine to make 10 years an interesting sector for investors and this has driven all the issuance in that bucket."
10 year demand insatiable
Indeed, it seemed that any sovereign, supranational or agency able to take on such an issue did so in the parade of benchmarks that followed, many of them issuers that had never raised 10 year funding in dollars, while others set new record sizes.
By late April the deals were still coming thick and fast. Perennial dollar favourite Oesterreichische Kontrollbank, for example, launched a $1bn 10 year through Goldman Sachs and Morgan Stanley.
PJ Bye, head of public sector syndicate at HSBC in London, sums up the trend: "Yields backed up in December but there was little supply, so accounts were keen to lock into the higher yield levels at the first opportunity they got in early January. There is the feeling that at some point soon the economy will slow down and that once clear evidence to that effect emerges the Fed will start cutting rates."
Bye adds: "Locking in 10 year yields at these levels therefore seems like a good trade and we have seen good 10 year buying consistently throughout the year. The bid is strongest when yields rise above the 4.7% threshold."
The story is similar in euros. Just two weeks after the wave of 10 year buying in dollars had allowed KfW to launch its largest ever dollar issue in the maturity, it was tapping into buoyant demand for 10 year paper in euros. It sold a Eu5bn issue via ABN Amro, Deutsche Bank and HSBC that was its largest in the maturity since 2003. The book of Eu8.9bn was its biggest on a 10 year since 2001. Three weeks into the year, KfW had raised almost a quarter of its annual funding requirement.
"This has been one of the busiest Januarys I can recall for KfW as we have already funded the equivalent of nearly Eu13bn, which is a very large amount," said Petra Wehlert, the agencys head of funding in Frankfurt. "We have done the long dated issues out of our benchmark programmes in dollars and euros, two very prestigious transactions, in less than a month.
"Last year we substituted the 10 year benchmark with a 15 year; it was quite obvious for us now to start with 10 years because we do not want such a large gap in the curve. All the flows are in the 10 year sector anyway so the choice was not difficult."
In the same week as KfWs Eu5bn deal, ABN Amro, Deutsche Bank, HSBC and KBC Bank built a Eu16bn book for a Eu5bn 10 year deal for the Kingdom of Belgium. Anne Leclercq, head of the Belgian Debt Agencys front office in Brussels, said one of the main reasons for the overwhelming demand, higher than on most syndicated government benchmarks in 2006, was that rates were over 4%.
"This is something we havent seen for a long time and 4% seems to be a magical number for investors," Leclercq said. "Also, some market players are expecting swap spreads to widen and in that area we are well placed because Belgium is viewed as a strong credit, which could follow any widening when it happens."
Demand for 10 year paper in euros has persisted, too. The Republic of Portugal, for example, attracted Eu10bn of orders in four hours for a Eu3bn 10 year OT in late April, led by Banco Espírito Santo, HSBC, Lehman Brothers, Morgan Stanley and Société Générale. "With yield levels close to 4.2% in 10 years, investors were very keen to participate," said a syndicate official at one of the leads.
Euro pleases ICO, OKB
In euros, investors appetite for paper has not been constrained to the long end. "There has clearly been a lot of liquidity in the market this year," says Seissinger at KfW. "In the dollar market it has been focused on the longer end and in euros on the wings, which is to say the two or three year maturities and 10 years or even longer."
KfW launched a Eu2bn two year issue at around mid-swaps minus 16bp via ABN Amro, Deutsche Bank and HSBC in early January, while Instituto de Crédito Oficial has sold two deals in that part of the curve.In January it launched a Eu1.5bn three year via Deutsche Bank, HSBC and Merrill Lynch at mid-swaps minus 12bp. In April came a Eu1bn 2-1/2 year via Barclays Capital and Credit Suisse, priced at mid-swaps less 14bp.
ICOs transactions were particularly surprising, coming from an issuer that had until last year shunned the euro market in favour of better funding arbitrage available in dollars. But as this report was going to press, ICO had even announced a third Eu1bn short-dated euro issue for the year, mandating Barclays Capital, BNP Paribas and Deutsche Bank for a five year benchmark the longest of its euro benchmarks to date.
Austrian agency OKB also hit a new high point in euros, with a Eu2bn five year transaction led by BNP Paribas and Citigroup in February. OKB had only launched one previous euro benchmark, a Eu1.5bn 10 year in September 2006, but its new-found enthusiasm for the euro, reciprocated by investors, enabled its follow-up issue to achieve a sufficient size to be traded on the EuroMTS electronic platform alongside the European Investment Bank, KfW and Cades.
Anish Gupta, senior manager, international finance at OKB in Vienna, said the transaction was a very important step forward for the issuer. "We are moving ahead in terms of building our curve in euros and diversifying our investor base.
"The Eu2bn size is an increase on the Eu1.5bn size of our 10 year and makes us eligible to trade on the quasi-sovereign platform of EuroMTS, which is another significant development for OKB."
World Bank tests euro waters
Arbitrage is the key to issuers surge in interest in the euro, combined with volumes that are as large as if not larger than what is possible in dollars. Even the markets most prestigious and therefore picky issuer, the World Bank, is maneouvring to place a euro benchmark.
As this report was going to press, the World Bank had mandated its first global benchmark bond in euros, a Eu1bn three year, which ABN Amro, Deutsche Bank and HSBC will probably launch in the third week in May. Were it to be priced inside where the EIB and KfW sell their Eu5bn benchmarks, it would achieve a level of demand comparable to what the World Bank could expect in the dollar market.
"There are only a couple of basis points between the two markets in three years, so why not spend another basis point or two and do something that is truly exciting and create a museum piece, along the lines of the Bank of England in the dollar market," said one banker in London, relishing the prospect of such a deal.
Although the SSAs are not trading as well in dollars, relative to swaps, as they were two years ago eroding the dollars attractiveness relative to euros other dynamics are also prompting borrowers to seek out new opportunities.
For the last several years, the MTN market has provided an attractive source of arbitrage for an increasing variety of top quality credits. While the World Banks lower funding requirement, compared to the 1990s, explains its relatively subdued benchmark issuance since the turn of the millennium, its increasing use of the MTN market has been another factor.
However, recently the structured trades that had given triple-A credits much of this attractive funding have not been feasible. "Volatility is low, markets are relatively stable, and yield curves are flat, so you are not seeing so much structured issuance," says Ed Mizuhara, head of frequent borrower syndicate at Credit Suisse in London. "That is partly why there has been a lot more short dated, 18 month to three year issuance from supranationals and agencies than there was two years ago, when they were getting so much great funding out of the Italian market, for example, with structured notes."
So while the 10 year part of the dollar market has been the favourite of issuers and investors, the short end has not been ignored. In late January, for example, KfW sold a $1bn two year issue via Credit Suisse and Lehman Brothers, and Landwirtschaftliche Rentenbank issued a similar trade in late February through HSBC and Lehman Brothers.