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A Swiss metamorphosis

10 Jan 2012

The Swiss franc market, with one of the world’s most conservative investor bases, paradoxically witnessed some of the most striking changes in buyers’ perceptions of safe havens in 2011. Stefania Palma explores what that means for the future now that markets’ conventional definitions of safe asset classes and jurisdictions seem to have been overturned.

The Swiss franc investor base showed an unprecedented spirit of adventure in 2011 by reaching out to new-found investment boundaries to shield itself from the escalating Eurozone malaise.

Market participants see this as the beginning of a permanent mutation in the Swiss franc sector and its investor base. "The market will develop further and move away from its homogeneous, top-quality type of structure," says Manuel Gadient, head of debt capital markets at UBS in Zurich. "This is a larger trend that will last well into 2012."

As part of this there were two main shifts in investor demand over 2011 — buyers grew wary of public sector borrowers, once considered the epitome of safety, and moved away from core jurisdictions into emerging markets risk.

One of the outcomes of this change in sentiment was a drastic drop in foreign sovereign, supranational and agency issuance from Sfr5.91bn in the first half of 2011 to Sfr1.23bn in the second half (as of December 6). "People no longer trust the public sector," says Gadient.

Investors’ growing diffidence towards triple-A international SSAs led to issuers such as the European Investment Bank, once considered a colossal borrower, to be quoted at 80bp over mid-swaps in early December. Its Sfr160m 1.625% 12 year note printed in late October had been priced at mid-swaps flat.

Swiss investors’ shyness towards foreign SSA issuers peaked after Moody’s and Standard & Poor’s downgraded Eksportfinans to sub-investment grade in November. Secondary market liquidity collapsed amid investor panic. Zurich-based dealers said market makers had almost stopped showing two-way prices.

Eksportfinans’ bonds widened to 400bp-700bp over mid-swaps during the week of November 28. The extreme move affected other Nordic borrowers such as Kommunalbanken, Kommuninvest, Municipality Finance and SEK, which widened by 40bp-50bp.

Swiss investors’ aversion towards international public names led to an equally strong shift of demand towards domestic issuers. These took advantage to issue at extremely tight levels. Pfandbriefzentrale issued a jumbo Sfr1.22bn three-trancher in the sub-Libor area in December.

"The home bias is ridiculous," says a Zurich-based banker. "Investors are driven by the fact that the Swiss National Bank protected the home market in 2008 and 2009. No other covered bond borrower could ever price at such tight levels. This is too extreme."

Unfavourable market fundamentals, as well as poor demand, hindered European SSA franc issuance in 2011. Arbitrage windows were short-lived in the first half. But a deteriorating euro/US dollar basis swap, in turn further worsening the euro/Swiss franc basis swap, reduced the already fickle arbitrage opportunities in the second half.

Core FIG: rejected

Senior unsecured issuance by European banks dropped sharply from Sfr8.73bn in the first half to Sfr952.45m in the second half of the year. While investors snapped up high yielding paper from Lloyds, Royal Bank of Scotland, Crédit Agricole and Société Générale in the first and second quarters, appetite for these credits disappeared completely thereafter due to increased panic over a deteriorating Eurozone crisis.

"We will continue holding off on financials as long as things don’t improve," says Michal Novak, portfolio manager, fixed income at Swiss & Global Asset Management, who correlates public sector woes to financials’ performance. "SSAs and banks are interconnected. If financials get into trouble, so do SSAs and vice versa."

Even covered bonds, originally considered safe, were shunned by investors in the fourth quarter, something that could well continue in early 2012.

Issuers like Landesbank Baden-Württemberg, NordLB, SBAB, SCBC and SEB flooded the market in September, but investors’ increased focus on these banks’ underlying credits as Eurozone turmoil intensified. "Before, you just bought a covered bond and felt safe," says Novak. "That’s not the case any longer."

The worsening arbitrage in the second half of the year kept European SSAs away from this sector and discouraged euro-based covered bond borrowers.

Corporate bonanza

A shift away from the SSA and FIG world led to a surge in investor demand for corporates, which became the ultimate safe haven in the fourth quarter of 2011 and is a situation that is set to persist into 2012. Swiss investors bought corporate paper — often irrespective of ratings and borrowers’ jurisdictions.

Some started believing in the corporate story even earlier, when financial paper became increasingly expensive after the 2008 financial crisis. "We started favouring corporates from 2010 when the correction in FIG spreads was complete and we no longer saw value in them," says Novak.

Corporate Swiss franc issuance as good as doubled from the fourth quarter of 2010 of Sfr1.83bn when compared with the same period in 2011.

Both European and emerging market issuers flocked to the Swiss franc market, which often remained open amid global market turmoil. "The second half of 2011 reminds me of Q1 in 2009 when international corporates found access to a resilient Swiss franc market, while tapping the euro or US dollar markets was not possible or extremely costly," says Gadient.

The main innovation in Swiss franc corporate activity was investors’ openness to credits lower down the curve. "In the old days, only highly rated and well known corporates found good demand," says Gadient. "In 2011, even corporates with limited name recognition and lower ratings were sought-after."

Even issuers from struggling Eurozone countries managed to tap this market. Although French financials had been on investors’ blacklists for months, construction and concession company Vinci managed to issue its debut Sfr200m 2.125% six year note in November. Buyers ignored its BBB+/Baa1 rating and growing nervousness around France. Triple-A covered bonds from the region traded in line with BBB+ French corporates that week.

The Swiss franc market also welcomed, perhaps as a sign of things to come, its first non-domestic non-investment grade issue in 2011 — HeidelbergCement’s Sfr150m 7.25% six year priced in November. This transaction would have probably been considered almost heresy not long ago, but Swiss investors’ yield hunt and strong preference for the asset class made this trade possible.

However, market participants have taken a step away from this frenzy and concluded that blind buying is unwise, even for corporates. "Investors have to realise that although corporate issuers may be rock solid firms, they still have an attachment to their country, even if they generate revenues abroad," says a Zurich banker. "Corporates are still affected by the laws, regulations and downgrades of their countries."

Emerging — the new developed

In addition to a move away from public sector debt, Swiss investors also drastically reassessed country risk in 2011 with an unprecedented move towards what used to be defined as exotic countries. UBS’s Gadient believes the widely recognised dichotomy between emerging and developed markets is bound to start fading further in the year ahead.

Emerging market borrowers started tapping this sector in 2010 but their activity peaked in 2011 with the return of Indian banks after a 23 year absence and Russian financials re-opening the FIG sector — one that had shut after investors stopped buying European risk.

"VTB Bank and Gazprombank selectively re-opened the market for senior unsecured financials after the environment turned more difficult in the summer," says Gadient. "Emerging market names offer exposure to growth economies and a great deal of diversification away from core Europe."

Korean issuers also played a key role in the EM segment with exceptional issuance levels in 2011. Volumes stood at Sfr1.825bn as of November 18 last year — already more than twice the Sfr850m issued in 2010.

A new stream of corporates joined state-owned banks to tap the Swiss investor base. Korea Finance Corp, Korea National Oil Corp and Korea Land & Housing Corp all issued inaugural trades. Credit Suisse and UBS also organised a non-deal roadshow for Korea Telecom in November, which plans to issue its debut transaction in early 2012.

A reversal in government risk analysis also benefited non-core issuers.

While European SSAs’ state proximity became a deterrent for Swiss investors in 2011, government involvement in EM borrowers increased these issuers’ reliability in buyers’ eyes. "Korean, as well as other emerging market issuers, usually have strong government involvement and offer reasonable spreads, which helps in this extreme low interest rate environment," says Novak.

  The doors shut: issuers rush in with old-style LT2s 
 Smaller domestic financials flooded the Swiss franc market in late 2011 as banks rushed to issue old-style lower tier two notes after Swiss regulator Finma ruled in October these would no longer provide eligible capital after the end of the year.

Swiss banks have rushed to build their already solid capital bases in the cheapest way possible. New debt instruments, which remain unclear and still have not been introduced to this sector, will have higher costs.

Expectations for bank capital generation in 2012 remain tentative. Some bankers believe the sector will not allow financials to raise sufficient capital to meet future Basel III and Finma regulations. "If you look at the capital banks are required to raise in the year ahead, the market will not be able to absorb the corresponding amount of new-style debt in such a small amount of time," says a Zurich-based banker.

Investor demand for these instruments was impressive with Swiss banks issuing Sfr1.1bn of lower tier two debt. Banca dello Stato del Cantone Ticino, Banque Cantonale de Genève, Julius Bär Group, Luzerner Kantonalbank, Raiffeisen Switzerland and St Galler Kantonalbank all tapped the market — most had never issued this type of debt before.

But some investors deemed these notes’ coupons insufficiently attractive to justify buying subordinated debt. "You get almost the same yield if you buy a Deutsche Bank or a UBS in senior unsecured format," says Michal Novak, portfolio manager, fixed income at Swiss & Global Asset Management. "So why should I buy a lower tier two instrument?"

10 Jan 2012