Investors might reasonably expect to pay up more for bonds that enjoy an explicit sovereign guarantee, which is usually couched in reassuringly absolutist terms like “first demand, unconditional and irrevocable”.
Some would rather take their chances on implicit guarantees, the reasonable assumption that a sovereign would cover an agency's debt in the case of default, even if the sovereign won't promise to do so in writing. They should expect, and usually receive, a little extra yield to compensate.
But sometimes, the distinction gets complicated.
Despite strenuous efforts from issuers and syndicate to clarify the differences, GlobalCapital has heard anecdotal reports of investors being surprised by “unusually cheap” assets, failing to notice the distinction of the implicit, rather than explicit guarantee — especially when issuers can print bonds in either format.
Take Unédic. The French unemployment insurance agency is one of the few issuers to maintain two programmes; one with an explicit guarantee, one with an implicit guarantee.
Its implicitly guaranteed notes have a tenor of up to seven years, while it issues longer dated deals from the explicitly guaranteed programme. Because of the different tenors of the programme, it is not entirely straightforward to compare the relative costs of issuing a new bond from each.
Bankers refuse to be drawn on establishing a figure for the spread the non-guaranteed programme offers but Tuesday’s non-guaranteed €1.25bn seven year benchmark was priced with the same 13bp spread to OATs as August’s €750m tap of an April 2032 line.
Both programmes have identical Aa2/-/AA ratings (the same as the French sovereign), are HQLA level 1 and have 0% risk weightings. Both are eligible for purchase by the ECB’s public sector purchase programme.
Expensive but worth it?
So, does the explicit guarantee really merit a price hike?
Moody’s says that explicit guarantees “suggest a very high likelihood of support and lifts the [government related issuer’s] rating to the level of the supporting government”. It judges non-contractual guarantees on “their individual merits”, looking at the government ownership of the agency, the history of state bailouts in the jurisdiction and the wording of what agreements are in place.
Other borrowers are less privileged. Dexia Crédit Local enjoys an explicit guarantee from the French, Belgian and Luxembourg governments. While the guarantors are severally, but not jointly, liable — meaning that creditors cannot pursue each one to make whole Dexia’s entire obligations — Dexia paper is still sovereign-backed.
But the agency still finds itself paying up as one of the cheapest names in the SSA sector — good value for a sovereign proxy with an Aa3/AA/AA- rating.
Dexia's bonds force one to wonder whether the name plays more of a role than the technicalities of a guarantee. Keeping the name of the beleaguered entity it exists to wind up has kept the Dexia trauma fresh in investors’ minds, unlike, say FMS Wertmanagement, Hypo Real Estate’s wind-up agency.
Of course, FMS-W does not have the complicating factor of the multiple guarantees to contend with, but it certainly seems from Dexia’s spread as though it continues to suffer because of its name. So branding seems to be worth more than the hard credit facts of guarantee structures — and maybe Unédic investors should carry on snapping up those "unusually cheap" issues.