Non-core opportunities abound despite swap cost woes
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Non-core opportunities abound despite swap cost woes

Sovereign, supranational and agency borrowers have greater flexibility to dip in and out of various currencies than perhaps any other class of issuer in the capital markets, something that many use to great effect. Nathan Collins outlines the pools of liquidity that canny borrowers should be looking at in 2014.

With central banks increasingly looking to increase the diversity of their currency reserves away from dollars and euros it has never been a better time for SSA borrowers to hunt for liquidity outside of their main funding currencies in the pursuit of cost-effective, diverse funding.

While the cost of the cross-currency swaps required to both hedge the issuers’ interest rate risk and allow them to swap bond proceeds into currencies they can use may look onerous compared to years past, syndicate bankers are confident that issuers will still look to tap a wide range of pools of liquidity, even if the arbitrage shrinks to just a handful of basis points. Indeed, an attractive basis swap into dollars and euros has meant that this year has already been an eventful one for sterling, for example.

Sterling sterling

The African Development Bank sold its first sterling deal in 23 years, a £250m three year note, in January and at the time expressed its desire to remain active in the currency. Similarly, February saw Japan Bank for International Cooperation (JBIC) return for its first trade in the currency for 17 years. 

There has even been interest from the eurozone’s periphery, with Spanish agency Instituto de Crédito Oficial meeting sterling investors early in March ahead of what could be its first deal in the currency since 2009.

SSA issuance in sterling focuses on the short end of the curve where the arbitrage versus dollars and euros is most apparent. Fortunately, this coincides with an area on the curve where major sterling investors such as central banks, domestic real money investors and UK bank and building society treasuries focus.

“The most attractive spot in sterling for arbitrage is at the short end,” says Kerr Finlayson, director on RBC Capital Markets’ SSA syndicate desk in London. “This part of the curve is also where a lot of these investors tend to do their buying as well. There are also pockets of demand in the belly of the curve, but the arbitrage is less obvious.” 

JBIC benefited from that demand with its seven year deal, but as the issuer did not need to swap the proceeds into another currency the lessened arbitrage was not a concern.

While larger UK investors may also buy dollar and euro paper, smaller investors remain focused on sterling, leaving the currency attractive for issuers looking to diversify their investor base.

“While the UK has plenty of investors involved in the dollar and euro market there are a number of smaller players who are only interested in sterling,” says Finlayson. “In particular some of the treasuries of the smaller building societies and county councils won’t look at other currencies — most of their buying is of sterling paper that they can repo with the Bank of England.”

One of the advantages of sterling is the ease with which issuers can advertise themselves to the investor base — London is a prime location for inclusion on roadshow schedules across core currencies so updating sterling investors is less onerous than many other currencies.

“Obviously it’s important to roadshow to keep investors up to date,” says Finlayson. “Particularly if you’re a new entrant to the sterling market. The advantage of a London roadshow is that you can hit dollar, euro and sterling investors all in one go.”

Duration the key to Kangaroos

The Kangaroo market is another important market for many SSA issuers — Germany’s Rentenbank raised 25% of its funding target in 2013 in Australian dollars, more than double the 12% it raised in the currency in 2012 — and the increasing prominence of Japanese investors in the market makes the currency a prime destination for issuers looking for duration.

SSAs have been fine-tuning their strategies in the currency, using a deft hand to tap pockets of demand rather than only heading to the currency in search of benchmark sizes.

“Issuers are less focused on the deal size than they used to be,” says Ben Powell, head of funding at the International Finance Corporation in Washington DC. “There isn’t as much focus on securing a jumbo size anymore. Borrowers have adapted their strategy to benefit from small bursts of demand.”

The average deal size for an SSA in Kangaroo format during the first two months of 2014 was around A$192m, according to Dealogic data. By comparison, in the same period in 2013 the average was around A$342m. 

However, the number of trades during the same period has increased from 16 to 23. SSAs are tapping the Kangaroo market more frequently with smaller trades. Part of the reason for this is the shifting investor base.

In the past, the main appeal of the Kangaroo market was tapping treasury demand at Australia’s banks — particularly the big four of ANZ, Commonwealth Bank of Australia, National Australia Bank and Westpac. 

However, the Australian Prudential Regulation Authority, announcing its latest decision on implementing Basel III rules on December 20, 2013, decided that bonds issued by foreign SSA borrowers would no longer count as high quality liquid assets suitable for filling liquidity buffers.

As such, issuers have increasingly been courting a different set of investors, particularly in Asia. Japanese life insurers and asset managers have long been active buyers of Kangaroo bonds, but now represent an even more important part of the investor base.

“Demand for Australian dollar paper in Japan remains strong,” says Salvatore Aloisi, director in fixed income origination and syndication at TD Securities in London. “These investors have minimum yield targets that are hard to reach in yen, so buying Kangaroo paper makes sense for them. The account base is very important to the market, they have a constant demand for paper.”

Fortunately for issuers, while the scale of their demand may not match that of the big Australian banks, their appetite is mainly at the long end of the curve. With long dated deals always a tricky prospect in dollars, the Kangaroo market offers SSAs a steady stream of opportunities at the long end — often with arbitrage in terms of funding costs.

“It’s a great market for adding duration to your programme,” says the IFC’s Powell.

Kauri and Canadian diversity

The Kauri market has enjoyed strong interest from SSAs over the last year. Issuance for the first two months of 2014 came to NZ$2.3bn, just shy of the record-breaking NZ$2.425bn seen in 2013. Even if the volumes are slightly short of last year, they still comfortably outstrip any other year on record. The closest contender is the NZ$1.05bn of bonds sold in the opening two months of 2008. 

The Kauri market has a reputation for being the little brother of the Kangaroo market, but what it lacks in size it makes up for in its opportunity for further diversification. The market is dominated by two main sets of buyers: central banks and New Zealand-based banks. SSAs are always on the hunt for more central banks to fill out their order books, while New Zealand-based financials are rarely seen outside of their home market.

“New Zealand balance sheet buyers aren’t generally active in other currencies and they’re one of the big drivers of Kauri trades,” says TD’s Aloisi. “This makes a Kauri deal good for diversification. The sovereign itself isn’t a big issuer, which plays in SSAs’ favour.”

SSAs enjoyed a resurgence in the Canadian dollar market last year, with the volumes of C$4.3bn easily eclipsing any other year since before the crisis. Bankers think that the currency could be just as valuable for public sector issuers in 2014.  

Like other banks, Canadian institutions have to hold larger pools of liquid assets driving up their demand for SSA paper. While bonds from Canada’s provinces and Canada Mortgage Trust are abundant and liquid, foreign SSAs can sometimes tempt the attention of Canada’s banks, says Richard van Nest, head of bond syndication at RBC Capital Markets in Toronto.

“Treasury desks are becoming more involved,” he says. “Canadian treasuries have a natural disposition towards buying in Canadian dollars. A trade from a non-Canadian SSA gives domestic investors a chance to diversify and sometimes a pick-up over provincial bonds.”

Unlike New Zealand’s domestic investor base, Canadian accounts are more likely to be seen in trades in other currencies. Even so, their natural bias towards their home currency means they aren’t necessarily opposed to doubling up their investments.

“They’ll buy more in a Canadian dollar deal than they would in US dollars,” says Van Nest. “And a trade in Canadian dollars doesn’t necessarily cannibalise demand from other currencies.”    

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