The year just past was a precarious one for supranational and agency borrowers. Although many made speedy progress with their funding programmes supranationals and non-GSE agencies raised $583.7bn equivalent last year, down 17% on 2009, according to Dealogic even some of the best rated credits in the market had to work hard for their rewards, accessing new markets and timing coming to market with extreme precision.
For those borrowers with closer links to the countries entangled in the European sovereign crisis the bond market proved an even trickier place in which to operate. "The challenge was proper execution," says Horst Seissinger, head of capital markets at KfW. "That means careful preparation of an issue and that meant very fast and clear decisions about the right timing."
The high grade new issue market went off with a bang in January. It turned out to be a year of things blowing up. BNG and the EIB (both twice), KfW, NWB, Rentenbank and Kommunalbanken all launched benchmarks in the first few days of the year.
It was a promising start to a month where supras and agencies issued more than $76bn of new debt excluding GSE credits, according to Dealogic, in the days when Greece was only a worry rather than a full blown disaster area.
Such positive conditions did not last, however, and volumes never reached such numbers again. When Greece was forced to go to the EU and IMF for a bail-out, SSA bond supply slowed amid soaring volatility and investor panic. Supranational and agency borrowers managed their second highest month by volume of the year on the cusp of the bail-out in April raising $60.9bn. Then the market froze over. In May they raised $41.4bn and in June, $48.8bn. Only in the traditionally quiet month of August and the last quarter of the year during which the Irish crisis blew up and investors closed their books early did volumes dwindle further. However, a nine month funding year fortunately many borrowers set out to hit their targets by the end of September meant that the majority of issuers were close to completing their funding programmes before October anyhow.
Dollar drought over?
Although volumes of issuance fell compared to 2009, August proved far busier than usual and much of this supply came in dollars. Supranational and non-GSE agencies issued $40.2bn of paper last August, some 64% more than in August 2009. It was the result of issuers tapping pent-up demand from funds held back during the Greek crisis of the spring and early summer; a time when issuance by supranational and agency issuance fell by around 40% year on year.
However, 2011 looks set for a strong start in dollars, due to a combination of factors. The basis swap for issuers funding dollar bonds with euros remains deeply negative offering them a large cost saving. Although non-European investors at times kept away from some European credits in 2010, the summer showed that appetite had returned and funds needed to be invested. That makes the economics of a dollar deal of great interest to European borrowers. So much so that it is driving some to look at putting 144A documentation in place.
Kommunalbanken and BNG made their 144A debuts last year and Municipality Finance and Kommuninvest both revealed recently they were weighing up the costs of setting up 144A programmes as MuniFin looks to bring its first public benchmark deal at some point in 2011. A back-up in US Treasury yields has also made the dollar market more attractive for investors.
Another factor driving European supras and agencies to the dollar market is the uncertainty in the euro. Barclays Capital, BNP Paribas, Deutsche Bank and HSBC lead managed a five year deal for the EU as part of the mission to bail out Ireland. The deal came in at Eu5bn in size in the first week of 2011. Later in the month, the European Financial Stability Facility is expected to follow suit and in between Spain, Austria and Belgium are all understood to be considering 10 year euro deals.
That makes the euro market both a crowded and uncertain place for the start of the year and issuers are choosing not to compete against such a wave of supply in what could prove a volatile market.
The dollar market also hosted two of a hat-trick of highlights from KfW a borrower that benefitted from a flight to quality bid that materialised as the sovereign crisis developed. The German agency priced two 10 year dollar benchmarks in 2010 and one in euros: an achievement in any year, let alone one of the most volatile in recent memory. The deals exemplified the borrowers ability to pick the right deal at the right time last year as it raised Eu75.8bn across 17 currencies.
"The most notable thing was how well KfW positioned itself in the market," says L-Banks head of international funding, Sven Lautenschläger.
The careful plotting required to navigate 2010 will stand issuers in good stead for 2011, say bankers, and the issuers with the best credit, such as Germanys Rentenbank, KfW and L-Bank, should look forward to being able to complete their expected Eu10bn, Eu75bn and Eu7bn-Eu10bn funding tasks in 2011. "It should be plain sailing unless investors suddenly get much more comfortable with peripheral sovereign credits," says BNP Paribass Nathaniel Timbrell-Whittle, who runs SSA debt capital market coverage in London.
The market in euros was at times a hostile place because of the sovereign crisis in 2010. Again, volumes compared to 2009 were down. The Eu154.9bn of new issuance that was priced in euros in 2010 was some 38% lower than the figure for the previous year.
Spains Instituto de Crédito Oficial was a borrower whose fortunes diverged from the core group of supras and agencies but was through careful timing able to take advantage of the summer renaissance to raise funds. Finding it was no longer priced alongside peer agencies but in line with the Spanish sovereign that guarantees it, the agency opted for a strategy of following positive sentiment in the aftermath of Spanish government issuance.
The deal that triggered markets back into life was the Spanish 4.85% 2020 bond issued in July. The deal attracted an order book of Eu14.5bn for a Eu6bn deal. Ico followed a day later with a Eu2bn three year deal that attracted an order book in the region of Eu2.5bn. A Eu1.5bn five year deal followed Spanish sovereign auctions later in the month and in mid-September the agency followed 30 year and 10 year government bond auctions with a Eu1bn seven year deal. As recently as December, Ico placed a ¥20bn 20 year placement with a Japanese corporate investor as its sovereign transacted identical business with the same investor.
There may well be higher volumes in the euro market in 2011 as bail-out borrowers, the EFSF and the EU on behalf of the European Financial Stability Mechanism, raise money for troubled sovereigns. There are also two new German agencies, Erste Abwicklungsanstalt (Aa1/AA-/AAA) and FMS Wertmanagement (-/AAA/AAA), that will be looking to issue public benchmarks in both euros and dollars. Both borrowers exist to wind down assets from WestLB and Hypo Real Estate, respectively, but have indirect sovereign or regional government support.One borrower that will almost certainly have to visit the market more in 2011 is Cades. Having issued Eu12bn last year, the borrowers funding requirement is expected to leap to Eu60bn-Eu70bn this year. The agency has said it expects to fund around Eu40bn in long-term markets with the balance raised from its short dated issuance. Meanwhile, EuroWeek understands that it is arranging a Eu10bn-Eu20bn loan facility through Société Générale.
Away from the core currencies of sterling, euros, dollars and yen, supras and agencies increased their activity. Compared to a drop in volume of a quarter in 2010 against 2009 in core currencies, issuance in all other currencies grew by around 15% to $154.7bn equivalent. Dealers reported booming Uridashi markets at the beginning of the year where higher yielding and safer haven currencies such as New Zealand and Australian dollars proved popular.
Japan has accounted for around half of Kommunalbankens funding in each of the last two years. "Japan has been a fantastic market for us since we started funding internationally in 2000," says Ben Powell, deputy head of funding at Kommunalbanken. "The Uridashi market has grown a lot recently and we have been fortunate enough to grow with it."
The Kangaroo market also boomed. Supras and agencies issued A$30.5bn of Kangaroo issuance last year compared with $19.1bn in 2009 a rise of nearly 60% according to Dealogic data. It was a market that provided funding for some of the credits viewed as safe havens.
Rentenbank is one such name that enjoyed success in the market and, like many borrowers, is looking at currency diversification as a way to reach more investors in an uncertain market. "This year we would like to diversify into different currencies more," says Stefan Goebel, head of treasury at Rentenbank. "We also want to maintain our large footprint in the Australian dollar market."
Nordic currencies also provided a safe haven for those looking for an exit from the euro. According to Dealogic data, supranational and agency Norwegian krone issuance increased by 30% year on year with Nkr39.4bn printed last year while Swedish krona deal volume increased almost 4-1/2 times to Skr53.9bn.
Issuance was targeted both locally and internationally with investors from Europe and Asia taking down Norwegian krone paper for its high coupons and stability. Among the Swedish krona borrowers responsible for the surge in volumes was Kommuninvest which launched a programme of domestic bonds to take advantage of the gap left by shrinking Swedish sovereign issuance. "These deals were a strategic decision to tap the domestic market," says Carl-Henrik Arosenius, Kommuninvests head of funding. "It has a long history of always being open and very liquid, so we thought it was time, when we are growing, to start tapping it."
Other Nordic supras and agencies also enjoyed the flight to quality that made the regions currencies such a hit last year. Municipality Finance issued public deals into the Swiss market. "There, of course, you can see a flight to quality because many of the Nordic borrowers or the agencies have been very active in the Swiss market throughout the years," says Joakim Holmström, head of funding at Municipality Finance. "We were in the market for a 20 year transaction, and we priced through KFW who were also in the market with a 20 year transaction at the time, so yes, in that sense, flight to quality has been seen."
Another group of borrowers that managed to attract issuance in 2010 was the Washington-based supranationals. Such was the clamour for their rare sub-Libor appearances in public markets that what started out as a four year private placement for the World Bank swelled to $2bn at the initial pricing in early August and had ballooned to a $4bn trade come mid-September. Barclays Capital tapped the trade for a further $200m in December.
There will be difficulties ahead for 2011, however, say bankers and borrowers. Aside from the market volatility surrounding the euro and the European sovereign crisis, issuers face potential regulatory hurdles.
Swap-providing banks that hedge new issues for borrowers and offer duration management derivatives can no longer provide swaps without charging for liquidity and in some cases, credit as the cost of finding collateral to post has risen as has the level of credit conservatism within risk management departments and among regulators.
That is forcing up costs to issuers and driving them to consider signing two-way credit support annexes with swap providers which would lower the collateral burden on those swap dealers and therefore, lower costs. However, signing such agreements could lead to issuers having to invest large sums into building collateral management operations, borrowers say.
Many borrowers argue they do not have the resources to cope with collateral management and do not pose enough of a credit risk to banks to warrant it.
There is also the possibility that if swap trading is forced through central clearing houses, as is being discussed in Europe and the US, those clearing houses would require daily margin calls which, again, borrowers say they are ill-equipped to manage. But further, there is concern among borrowers that certain structured swaps will be banned. That could close off avenues of funding such as structured MTNs which form a large part of many supra and agency borrowing programmes.
There are other regulatory concerns. "Regulation is also one key element this year with Basel III and all the new capital requirements and leverage ratios," says Holmström.Competing supply from US bank covered bond issuers and a general increase in dollar benchmark supply threaten the cost of funding for supranational and agency borrowers through diluted demand. "There is potentially a lot of dollar benchmark bond issuance to contend with," says Kommunalbankens Powell. "Also, US bank covered bonds replacing some of the depleting agency supply might attract the US portion of our investor base away from our issuance."