Expanding agency sector reigns in eurozone turmoil

Germany’s public sector issuers have been able to reap the benefits of being at the very centre of the core of the eurozone. Investors have flocked to German credit while many eurozone sovereigns have seen their buyer bases disintegrate. But can their place in pole position last? Tessa Wilkie reports.

  • 23 Nov 2011
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The eurozone’s sovereign bond sector has been in turmoil for much of this year but the German public sector has been hot property.

Investors have clamoured for safe assets that offer a pick-up over benchmarks, and many German agencies have come as close as any issuer to satisfying these demands.

KfW is one such borrower. Meanwhile, old rivals such as the European Investment Bank and new ones like the European Financial Stability Facility have, in some investors’ eyes, become less desirable because they are so tied into the eurozone as a whole.

This flight to German issuers has allowed the country’s public sector borrowers to get funding at tremendously low rates. Because Bund yields are exceedingly low, issuers can still offer attractive yields in relation to Bunds, while offering low yields in relation to benchmarks such as mid-swaps.

Rentenbank, for example, sold a €1.25bn 10 year in August at one of the tightest yields all year over mid-swaps for that currency and tenor. The agency priced its deal at 10bp over mid-swaps, with that pricing translating into a spread of 74.9bp over the 3.25% July 2021 Bund.

And the dynamic has endured since the summer. KfW printed a two year benchmark on November 8, which, despite being priced at mid-swaps less 50bp, still offered a pick-up of 52.3bp over Germany.

"At the moment we can attract investors who are keen to get an interesting Bund spread," says Petra Wehlert, head of funding at KfW in Frankfurt. "Bund spreads make agencies interesting all over the curve despite the low yield environment. For example, in the three year part of the curve with a Bund yield around 50bp investors can more than double the yield if investing into KfW paper which is trading at Bunds plus 60bp."

International buyers

Many Germany agencies have attracted increased international investor participation in their deals this year. NRW.Bank printed a three year dollar deal in January, 97% of which was bought by non-domestic investors. Its five year euro trade, sold in May, had the lowest domestic participation level of any international euro deal the issuer has sold.

"There has been a shift in our investor base, geographically," says Frank Richter, head of investor relations at NRW.Bank. "We were quite happy to compensate the lack of European demand with non-European demand. Due to the current spread in the eurozone sovereign market, we were able to attract central banks from Asia, South East Asia, Latin America and oil producing countries."

Rentenbank has had a strong following from investors based in the Americas this year, and it has also marked an increase in demand from African investors.

"We have a broadening base among US real money investors," says Stefan Goebel, head of treasury at the agency in Frankfurt. "There is less US agency issuance than there had been. Plus the euro/dollar basis means that we can issue at a nice level in dollars. In a low yield environment we can offer a very attractive pick-up over Treasuries. Investors based in the Americas account for 15% of our long term funding. That is a definite increase on previous years."

This is something many issuers will build on next year. NRW.Bank has investor meetings in sub-Saharan Africa slated for January. It will also head to Asia, the Middle East and Latin America.

But while Germany’s public sector borrowers are pulling in new investors to their deals, the low yields on offer could alienate established buyers. While many investors, such as central banks, look to the Bund as a pricing benchmark, others may look to their own government benchmark, and that can make the likes of KfW look expensive.

"We are at a point where longer-dated issuance is not as attractive to investors due to the low yield environment," says Sylvia Moussalli, executive director in SSA origination at Morgan Stanley in Frankfurt.

"KfW is trading through the Obligations Assimilables du Trésor, which makes it tough to capture French investor demand. In certain maturities, for over five years, you need those investors. This could affect longer-end issuance for the likes of KfW in particular because of the size of its funding needs. It won’t affect whether KfW can do a trade, but it could affect whether it can do a €3bn or a €5bn trade. It remains to be seen what is the minimum spread level investors will accept."

But there are no signs of investors having a problem with KfW’s pricing for now. Its most recent trade — a targeted €1bn-€2bn two year — attracted orders over €2bn within an hour, and was priced at mid-swaps less 50bp.

"As long as bunds are trading at these tight spreads versus swaps, KfW continues to look very attractive to investors at current levels," says Achim Linsenmaier, director in the liquid credit syndicate at Deutsche Bank in Frankfurt. "Its latest two year has shown that the current flight to quality helps them a lot to achieve attractive funding levels whilst it still offers a decent premium to investors compared to Bunds."

New arrivals

But it won’t all be plain sailing for German agencies. The sector could be in some danger of overcrowding.

Two new agencies appeared on the scene this year. FMS Wertmanagement and Erste Abwicklungsanstalt (EAA), the wind-down agencies for the unwanted assets of Hypo Real Estate Group and WestLB, respectively, launched MTN programmes and CP programmes in 2011.

Their arrival prompted worries that new agencies could affect pricing for the existing ones. Both agencies offered a pick-up over KfW. As it is, demand for German agency paper has proved resistant — so far.

The large number of sovereign, supranational and agencies borrowers on the European scene, and the large amounts they have needed to fund has already led issuers to alter their behaviour.

It was a factor in shortening the summer break as issuers aimed to get out of the gates ahead of what was expected to be a heavy programme of issuance in September. Rentenbank was one such borrower to print in August.

"We were aware that the EFSF and the EU were likely to issue, and they might come in the same maturity with spreads 10bp-15bp wider," says Goebel of the timing of Rentenbank’s 10 year in August. "If you come with a 10 year 10bp-15bp tighter after those borrowers, investors might raise questions about the relative value."

Next year could be even more crowded, and a big test will be whether the investor flight towards German issuers will keep spreads down in spite of the hot competition.

"What may put pressure on spreads is competition from new issuers," says Moussalli. "It hasn’t really disrupted KfW spreads yet. However, second tier issuers could be more affected by the additional supply and volatility."

One region that could be vulnerable to overcrowding is the State of North-Rhine Westphalia, for example, where there are several agencies with state backing.

"A challenge a number of issuers have to face is that some investors are using the same credit lines if they are backed by the same region," says Linsenmaier. "The flight to quality and the flight to Germany might help to compensate for that supply."

On top of these new issuers comes the possible return of government-guaranteed bank issuance, which will produce even more competing supply.

"When all of the government-guaranteed issues came to market even KfW’s spreads blew out," says Ewald.

While German issuers have benefited in some ways from problems in the eurozone — being able to hoover up demand from investors who are not so keen on Spanish or French agency credit, for example — the extreme instability and volatility that has rocked the region could come to harm issuers.

Extreme volatility

The extreme volatility in early November as Italy’s debt problems intensified was not helpful for any eurozone issuer.

Volatility and uncertainty can make the window for pricing benchmarks smaller and the business of raising funds in the public market more hazardous.

Much of Germany’s public sector borrowers fate is tied up in that of the political solution to the eurozone sovereign crisis. If investors become worried about the eurozone as a whole, Germany’s borrowers could end up being caught up.

Germany’s public sector borrowers have had an impressive year, but they cannot afford to sit back. They will need to watch out for overcrowding, as well as the possibility of extreme volatility in the eurozone making public issuance tough.

But investors have few safe havens open to them, and German agencies are among the best placed to navigate tough conditions next year.

  Shifting over to bonds 

While the international public bond markets are the mainstay for many of the larger German public sector borrowers, for smaller issuers the Schuldschein and bank loan markets have been the funding sources of choice. However, investor demand is driving some of these less frequent names to consider printing bonds.

Investitionsbank Sachsen-Anhalt, the development bank of State of Saxony-Anhalt, is one such issuer. It has low funding needs — it only needed to raise around €300m-€325m this year — and has hitherto used bank loans or Schuldscheindarlehen to fund this. But investor demand has led it to consider setting up an MTN programme. It has found many buyers that want bonds eligible for repo at the European Central Bank.

"We have only been active in Schulscheindarlehen and banking loans, but there has been a big shift in investor demand towards bonds this year," said Michael von Eyss in treasury at Investitionsbank Sachsen-Anhalt. "That’s why we are thinking about issuing bonds very intensely. Due to the funding volume we probably will do only private placements."

An MTN programme could help the borrower meet investor targets. Its main investor bases are insurance companies and banks. Insurance companies in particular often have yield targets to meet. One way in which to meet those target is printing structured MTNs.

"Setting up an MTN programme is a further opportunity in case of increasing funding needs," says von Eyss. "MTN documentation gives us the ability to access the structured market. A lot of our investors are looking for yield as there are falling interest rates. We often hear from investors such as insurance companies that they are targeting a yield of around 4%. As we don’t have to pay high rates from a credit perspective, structures could help us offer this. We would look to simple structures, however, such as callable bonds."

  • 23 Nov 2011

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