Agencies sharpen tactics in year of the yield grab

Agency bond issuers, like borrowers from many other sectors, wasted no time in getting deals done this year. It is a group of issuers that encompasses those with big borrowing programmes, like KfW’s roughly €90bn need, to a number of issuers that raise €10bn or so each year. But although this varied group have learned to play alongside behemoths like the European Union and the big supranationals in the primary market, they must still find new ways to engage investors in their deals.

Agencies had raised $150.6bn-equivalent in syndicated benchmarks in core currencies by the middle of May, according to GlobalCapital’s Primary Market Monitor (PMM), up 12% versus the same period in 2023.

Borrowers began 2024 by front-loading issuance ahead of what is expected to be a volatile and less predictable second half, with the US election looming in November, and wars in Ukraine and the Middle East. But facing restricted issuance windows thanks to a mix of economic data, central bank meetings and competing issuance means they have not been able to be complacent.

The good news is that with rates thought to have peaked in July 2023 in the US, and September 2023 in Europe, and even with US inflation proving sticky in 2024, investors have taken to the primary market to pick up agency paper at attractive yields versus government benchmarks. “We haven’t ever seen this level demand in order books,” says Asif Sherani, managing director, head of DCM syndicate EMEA at HSBC.

Euro benchmarks have been 5.1 times oversubscribed on average, versus four times in 2023, according to PMM data.

But issuance has not been straightforward. Persistent tightening in euro swap spreads between Autumn 2023 and April 2024 has made it tougher for some agencies to price deals, and for bonds to perform in the aftermarket against government benchmarks.

KfW is typical of many agency issuers in that it markets its bonds to investors at a spread to Bunds as well as swaps but pays for the debt with floating rates by way of a new issue swap hedge, making it sensitive to the spread between swaps and government bonds. While last year, in the five to 10 year sector KfW spreads had hovered around 50bp-60bp over Bunds, they are currently trading closer to 30bp-40bp and around 20bp at the short end.

“At some point, that Bund spread will become important again,” says Sherani. “Historically speaking, the SSA sector starts to look expensive inside 30bp versus Bunds, but above 30bp is still an attractive relative value point.”

In the dollar market, KfW had priced two short-dated dollar benchmarks this year, by the time this report went to press, at 10bp over Treasuries. “There is not as much of a cushion at the moment in terms of additional performance in dollars given issuers are coming up against these tight valuations versus Treasuries,” says Ebba Wexler, head of SSA DCM at Citi.

While bankers say tighter spreads have not materially dampened appetite for SSA paper in the primary market, investors have still been prioritising liquidity amid bouts of extreme volatility across global bond markets this year.

Guaranteeing liquidity can be difficult, particularly for small agencies with funding needs of less than €10bn, and with limits on the size of benchmark they can issue. Antti Kontio, head of funding and sustainability at Finnish agency Municipality Finance, which is targeting €9bn-€10bn of funding this year, says that while there is an illiquidity premium associated with smaller names, “it feels like that has diminished for MuniFin” as new buyer bases have entered the market.

Kontio says the euro secondary market has been tougher in 2024 as issuance has outstripped volumes raised during the first five months of last year. Across the entire market, SSAs had raised €320bn by around mid-May, an increase of 20%.

Issuers have been adopting measures to increase the liquidity of their bonds, including targeting larger, public benchmarks and taps.

“If the bonds aren’t big enough, investors hold on to them and that harms our liquidity,” says Thibaut Makarovsky, head of funding and market operations at Agence Francaise de Développement. “We return sometimes to the market to tap our benchmark issues for this reason.”

French agencies have capitalised on strong momentum for their paper this year, as OATs have underperformed, but supply from this group of issuers remains scarce. “The French agency sector is enjoying strong demand but there’s a scarcity dynamic and it wouldn’t surprise me if there is less turnover in our sector,” adds Makarovsky.

While dollar issuance is up year-on year across the segment, by nearly 40%, according to PMM data, there is still not the same volume as there has been in euros which has impacted buying in the secondary market. Most investors save their firepower for the primary market in euros. In dollars, there have been periods of slow issuance, which has driven greater activity in the secondary market.

In order to tap into as many investor bases as possible, bankers say issuers are looking to diversify into different currencies, as evidenced this year through large deals in markets like sterling, Australian and Hong Kong dollars.

Chinese yuan and Hong Kong dollars are now KfW’s fifth and sixth biggest currency markets, with CNY issuance last year exceeding €1bn for the first time. Petra Wehlert, the issuer’s head of capital markets, says issuance has allowed KfW to tap into central bank reserve manager demand, while in Hong Kong dollars, even though supply is only very short dated, flows have been constant.

Issuers do not want to be solely reliant on euros and dollars in case of volatility spikes that have the potential to shut core primary markets. During the pandemic, many agencies were able to tap niche currencies to get funding done.

But the market is moving in favour of syndicated offerings and away from small taps and private placements and it is not always easy for smaller agencies to access every market. “Our currency strategy is to diversify as much as possible,” says Kontio. “We’ve been very active in different markets and, in general, the market is moving more towards big, liquid, public issues. We haven’t been able to control that trend.”

While diversification has previously delivered cost advantages, pressure on the cross-currency basis swap, which is sensitive to flows, means MuniFin has been less active this year. Aussie dollar issuance looks more expensive than euros, for instance, says Kontio. “The basis swap is driven by flows and other components. Trying to draw conclusions as to why it doesn’t work is very difficult and the reasons vary between currencies. We’re not miles away from our target levels but it makes sense to wait a little longer to issue,” he says.

As issuers have sought to build up the liquidity of their bonds, agency borrowers have increasingly gone head-to-head in the primary market as they try to squeeze into narrow windows for issuance.

“Since the global financial crisis, the market has become increasingly prone to volatility, both day-to-day as well as intraday,” says Alex Barnes, head of global SSA syndicate at Citi. “As a result, issuers and investors want to be in and out of the market as quickly as possible and technology has had a significant impact on our ability to speed up the book build process.”

Wehlert agrees, saying: “Book building is faster these days. And we incentivise that by prioritising early orders during allocation. Without investors with market views and larger tickets, the bookbuilding process would be quite inefficient.”

The German policy bank has prioritised dual-tranche transactions to optimise each outing. It got a taste of how sensitive the market can be to policy rate expectations in April when, during a two year dollar pricing, market predictions changed, sending 10 year Treasury yields past 4.6%. “That was a challenge for investors,” says Wehlert.

Nonetheless, the pace of deals this year suggests that issuance windows are less of a problem than they were a year or two ago. Sherani argues that the debate about windows has been rendered “redundant”.

Even so, issuers time their deals with care. Kontio says that while MuniFin avoids pricing a similar trade to its Nordic or Dutch agency peers on the same day, bringing a new issue on the same day as KfW is no longer a deterrent.

The EU continues to dominate issuers’ thinking, according to market participants. It remains to be seen if consultations this year by sovereign bond index providers can ease worries about being in the market at the same time as an issuer that does such size so often — it regularly prices €5bn or more at a time as it looks to raise roughly €150bn each year.

“The EU takes a lot of the attention, both in primary, where its issuance is seen as a large liquidity event, and in secondary where traders are also focused on the borrower’s new issuance,” says Barnes.

The consultations about index inclusion have pulled in EU spreads, and agency spreads along with them. This year the EU has “become less of a stigma”, with more issuers approaching the market at the same time as the supranational, according to Barnes.