Libor limbo: how low can the cost of funding go?

Eye-wateringly tight swap spread levels and ultra-low yields look like they might be about to threaten what has turned out to be a golden age for the best SSA credits. As the US struggles with its fiscal cliff and the European sovereign crisis rumbles on, Ralph Sinclair assesses what lies in store for top-rated borrowers.

  • 21 Dec 2012
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In years to come, global capital markets might well look back at the autumn of 2012 as something of a crossroads for the best credits in the supranational and agency bond markets.

On the face of it, all was normal — the International Finance Corporation (IFC) succeeded with a five year global benchmark and was followed by Nordic Investment Bank (NIB) and Export Development Canada (EDC).

Indeed, such an autumnal spree is nothing spectacular in itself. But the detail of the issuance was telling. The IFC restricted its deal to $1bn long before books were opened whereas previously the possibility of $2bn deals had been common and EDC’s deal came flat to it while NIB’s offer was not fully sold.

All three of those signs point to the effect that low swap spreads and low yields are having on the SSA new issuance market.

Deals that struggle to reach a re-offer spread of 10bp over US Treasuries are beginning to test investor limits as to how little issuers can pay and they have allowed borrowers such as EDC to close the spread gap between themselves and the Washington supranationals.

But as a lead manager on one of the deals says: "These levels are eye-wateringly tight but the deal still got away. But it can’t last."

The signs are already there: smaller deal sizes and lower levels of subscription. But this could put the supranational class in something of a dilemma, especially the World Bank, which looks to raise between $3bn-$6bn typically with its benchmark dollar deals.

The World Bank has not attempted a benchmark since the start of its fiscal year but it will come at some stage before that year ends next June.

"We’re very well funded and are seeing a lot of reverse enquiries at very attractive levels through MTN and private placement markets and in other currencies which is why we haven’t come with a dollar benchmark since our fiscal year began in July so far," says Heike Reichelt, the World Bank’s head of investor relations and new products. "But we want to and we will."

But how to approach benchmark markets when investors wince every time they look at the Treasury spread on offer? And when they do not turn up in the size that, throughout the financial crisis years, the best credits had gotten used to?

"For the very tight names in the SSA sector I do think it will be more challenging to raise large volumes through individual trades in the dollar market in 2013," says Ben Powell, senior financial officer at the IFC, which must raise — at the time of writing — just under $5bn by the end of its fiscal year in June, just under half of its $10bn funding task for the year. "Our deal in November yielded around 0.75% for a five year term. It isn’t a question of credit, just where absolute yields are at the moment."

The IFC traditionally has run a very steady issuance programme based upon one or two benchmarks every year that have become something of a market event to set your watch by.

"We trade tight for a reason," says Powell. "But we will have to be a little more flexible and nimble in terms of issuance from now on. We have a very global investor base that supports our programme but we may see a bit of a shift in the way deals are done. Over the past few years, IFC has raised 40%-50% of its programme from just two benchmark dollar deals. We have the potential to consider three if the opportunity is compelling. But there’s also a rarity value to our name so it is also about increasing the number of products we issue in different markets."

There was clear evidence of that new approach to flexibility in the timing of the IFC’s November deal as it waited for the right window into which to print a deal rather than risk clashing with a US presidential election and Hurricane Sandy.

With investors desperate for yield and with increased supply from the sector expected overall — Société Générale estimates that SSA issuance volume in euros will rise from €290bn in 2012 to €372bn in 2013 — and with better yielding issuers such as the European Stability Mechanism (ESM) expected to come to the market, there is a clear case for tougher times ahead for the top credits.

"It will be tougher in 2013 than it turned out to be in 2012," says one head of debt capital markets at a leading SSA dealer. "Spreads and yields cannot go much lower. If and when yields do go back up it will be an ever tougher market then too."

For the World Bank — for whom there is a consensus of opinion that raising whatever funding it needs will be no problem as long as the institution is prepared to pay the right price — the flexibility to access a range of markets has been key to its success so far this year and has compensated for what may have been tricky conditions in the dollar benchmark market.

"It has been a good solid market all round for our peer group," says Doris Herrera-Pol, head of capital markets at the World Bank. "The market environment has been good for our average cost of funds, good for the range of currencies we’ve accessed and good for our duration."

The World Bank, by late November, had raised around $7.5bn of its $25bn-$30bn funding task for fiscal year 2012-2013.


European credits

The top credits in Europe, such as Germany’s KfW, are perhaps even more fortunately positioned than they were last year.

Carrying an explicit German federal guarantee — a feature that compatriot borrower Rentenbank will also boast this year — means KfW can offer superior credit quality while still offering a spread to the Washington supranationals and its sovereign guarantor. That is just as well given KfW is likely to have to find around another €80bn in 2013, although the final amount has yet to be agreed.

But this was not the only reason behind its success in capital markets last year, during which it enjoyed a series of well received deals including bringing two 10 year dollar globals for only the second time in its history, according to Horst Seissinger, head of capital markets at KfW.

"It is true that we benefit from the advantage of ownership by and a direct and explicit guarantee from the German state, but it is also our strategy and teamwork that helped us so we see no need to change this approach for 2013," he says.

That strategy meant taking the offensive when it came to issuing paper, or at least avoiding too defensive an approach.

"The market has three modes," says Seissinger. "Risk-on, risk-off and do nothing. The challenge has been not to wait for the best window ever in which to issue but to be in the market where there seems to be an opportunity and avoid looking like a rabbit in the headlights."

Compared to the Washington supranationals, KfW has more to raise and does not rely so heavily upon the same global central bank investor base. As such, chasing every possible investor will remain another core element in its approach to funding, it says.

One way it has achieved this and which it expects to continue to do so is to be among the few credits that offers more than just fixed rate dollar benchmarks in global format. It remains one of the few issuers that can offer euro globals as well as other deals in the format.

"One part of our strategy is to offer different products in global format," says Petra Wehlert, head of funding at KfW. "We have offered dollar floating rate notes paying one month Libor aimed at US investors and ones with three month coupons aimed at central banks. We could do even more like this but it is very much demand-driven."

That attempt to access different investors is a strategy likely to be mimicked by a whole range of German SSA borrowers. Although Rentenbank should still be able to trade off its rarity value and new guarantee status, other German SSA borrowers face competition between themselves and from new members of their peer group.

WI Bank is just one example. The development bank of the German state of Hessen made a confident debut in November. The borrower attracted a €2.2bn book to a €500m deal. It expects to bring two to three benchmarks each year.
  • 21 Dec 2012

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Rank Lead Manager Amount $m No of issues Share %
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1 Citi 37,598.23 170 9.48%
2 HSBC 34,028.88 217 8.58%
3 JPMorgan 26,223.43 127 6.61%
4 Standard Chartered Bank 24,070.02 150 6.07%
5 Deutsche Bank 21,898.85 77 5.52%

Bookrunners of LatAm Emerging Market DCM

Rank Lead Manager Amount $m No of issues Share %
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1 Citi 11,343.89 36 17.74%
2 HSBC 7,749.23 19 12.12%
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4 Deutsche Bank 5,950.19 7 9.31%
5 Bank of America Merrill Lynch 4,165.66 17 6.51%

Bookrunners of CEEMEA International Bonds

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1 Citi 14,691.58 46 11.05%
2 Standard Chartered Bank 13,765.00 47 10.35%
3 JPMorgan 11,619.88 47 8.74%
4 Deutsche Bank 11,156.18 26 8.39%
5 HSBC 9,244.84 41 6.95%

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Rank Lead Manager Amount $m No of issues Share %
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5 Citi 95.36 35 5.16%

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1 UniCredit 4,103.45 23 14.66%
2 ING 2,532.09 20 9.04%
3 Credit Agricole CIB 2,151.31 8 7.68%
4 MUFG 1,818.52 8 6.50%
5 Credit Suisse 1,802.80 1 6.44%

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Rank Lead Manager Amount $m No of issues Share %
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1 AXIS Bank 5,175.29 96 22.23%
2 HDFC Bank 2,870.62 60 12.33%
3 Trust Investment Advisors 2,641.11 83 11.34%
4 ICICI Bank 1,804.53 61 7.75%
5 AK Capital Services Ltd 1,546.74 70 6.64%