Out of the ashes of the Lehman collapse in September last year was born a new asset class: government guaranteed bonds from banks. A by-product of the crisis, the necessity for governments to guarantee the bonds issued by banks quickly became clear as trust had all but disappeared and banks found that they could not access the market without help.
For public sector issuers who up until then had the scene to themselves and had always been able to rely on the flight to quality from investors at times of crisis, the arrival of this new asset class changed the market dynamics completely.
"We saw a sea change in the market for traditional SSA issuers at the end of last year," says Martin Egan, head of global primary markets at BNP Paribas. "There was some uncertainty as to whether this would continue, and it has and that is for a number of reasons, one of which was the overall increased supply of that issuer base alongside the inception of the government guaranteed asset class."
The first bank to issue bonds with a government guarantee was Barclays Bank in October last year. The Eu3bn self-led three year was well received by the market, attracting over Eu4bn of orders and priced at 25bp over mid-swaps.
Since that first issue, the pace has been relentless. Indeed, according to Dealogic data, almost $510bn (equivalent) has been raised across the globe by banks since issuance began.
This issuance has all come at spreads well above mid-swaps, from mid to low 30s in the case of the UK and German banks to as high as almost 200bp over for the Irish banks. However, while clearly the government guaranteed banks had an impact on the pricing levels of the traditional public sector issuers, market participants say they are not solely to blame."This spread widening was more to do with the increased supply from sovereigns, the agencies and municipalities," says Zeina Bignier, head of sovereign, supras and public group debt origination at Société Générale in London.
"Indeed, if you look at supply so far this year versus the same period last year from financial institutions, it is actually lower. Last year, we had Eu174bn including covered bonds and unguaranteed while this year, even including the government guaranteed, there has been Eu155bn of supply. Meanwhile, sovereigns have issued Eu413bn in 2009 versus Eu270bn last year and while this includes some frontloading, we still expect overall supply to be up around 35% this year. One of the other real changes comes from the municipalities. Because these institutions do not lend as much, we expect supply from municipalities to go up from Eu12bn in previous years to Eu40bn this year."
Issuers agree that while government guaranteed bonds have had an impact, they are not solely to blame. "While government guaranteed issuance from banks is one of the problems, the widening in spreads cannot solely be blamed on them," says Stefan Goebel, co-head of treasury at Rentenbank.
"The threat of ballooning public sector debt and the deterioration of the credit quality of sovereign is the reason why we have seen spreads widen by 60bp-100bp against Libor. So, we do not feel that government guaranteed bank debt has really had an impact."
One thing that has been notable is how quickly issuers have adapted to the new pricing levels. Indeed, rather than sticking their heads in the sand the traditional public sector borrowers rapidly adjusted their pricing levels.
"One thing that has been very clear in the first quarter of 2009 is how appropriately the SSA issuers have reacted to the change in the market after the initial shock and horror," says Egan. "Most have been pragmatic and realised that the market would be challenging and that they should manage their funding programmes carefully as a result. Those with bigger programmes have been flexible in terms of structure, maturities, currencies and price."
For instance, the Nordic Investment Bank (NIB) that had never done a benchmark in euros before priced a Eu1bn five year via BNP Paribas, HSBC and JP Morgan at the beginning of April. At the time, Kari Kukka, head of funding and investors said that the euro market offered a more viable execution route than the dollar market.
Instituto de Credito Oficial (ICO) is another issuer that has opted for an atypical currency. At the end of April, the issuer priced its first Samurai for around 10 years, a ¥50bn dual tranche five year via Daiwa Securities SMBC, Mitsubishi UFJ Securities and Mizuho Securities.
Pricing still better
However, while they have had to adapt their pricing, currencies and maturities, traditional public sector issuers continue to be able to price deals tighter than the financial institutions issuing the government guaranteed bonds.
In March, Instituto de Credito Oficial priced a Eu2bn three year via BBVA, Credit Suisse, Goldman Sachs and Société Générale at 75bp over mid-swaps. The same week, Caixa Catalunya was in the market with a three year government guaranteed bond which was priced at 85bp over.
KfW has also been able to command levels tighter than where German guaranteed bonds can price. In February, the agency priced a Eu5bn five year at 47bp over mid-swaps via Citi, Deutsche Bank and UBS. Two weeks later, at the beginning of March, IKB Deutsche Industriebank priced a Eu2bn three year at 45bp over mid-swaps via Barclays Capital, Deutsche Bank, JP Morgan and UniCredit, a tighter spread but a shorter tenor.
Even issuers not backed by an explicit guarantee but with state or municipalities ownership, such as Bank Nederlandse Gementeen (BNG) or Rentenbank have done well despite the arrival of the government guaranteed bank issuers.
"What is interesting in the current market is that banks are showing us re-offer levels that are through where the three year Fortis priced and the NIBC five year came," says Bart Van Dooren, head of funding at BNG.
"It is clear that investors do value our track record and the long standing relationship that we have with them."
Egan at BNP Paribas echoes this view.
"What the SSA issuers have as strong selling points are their track record, history, liquidity and frequency," says Egan. "Investors know that generally, they will get good liquidity in these bonds and that those issuers have longevity in their programme which is an advantage."
On the other hand, most government guarantees for the banks are expected to expire at the end of the year meaning that issuance will dry up and liquidity in the bonds which is already quite scarce will drain away.
As well as liquidity and a strong track record, what the traditional public sector issuers have been able to offer unlike the government guaranteed bank bonds is no underlying credit risk. Indeed, in a lot of cases, even when the guarantees are in place, investors tend to look through at the underlying credit.
"We feel that as an issuer, when it comes to looking at standalone quality, Rentenbank is much better positioned than the government guaranteed bonds from the banks," says Goebel.
"When government guaranteed banks issue in their own names, investors still have to look at both the credit and government guaranteeing the bank, something they do not have to do with us. We benefit from the maintenance obligation from the German government which translates into a zero risk weighting in Europe and other countries and the rating agencies describe the absence of a direct government guarantee as inconsequential."
While no underlying credit risk has acted in the traditional public sector issuers favour, their access to a range of maturities has also helped ease supply pressures. Indeed, most guarantees do not go beyond five years while traditional public sector issuer can access any part of the curve.
Recent deals from the Province of Ontario, the Government of Quebec, EIB and KfW, showed renewed investor appetite for 10 year paper. The most recent deal was from Quebec which priced a Eu1.5bn 10 year via Bank of America-Merrill Lynch, JP Morgan, Royal Bank of Scotland and Société Générale at the end of April. The deal attracted a book in excess of Eu2bn allowing for pricing at the tight end of the 160bp-165bp over mid-swaps.
"The re-opening of the 10 year part of the curve is very positive," says Bignier. "We have seen deals for the EIB and KfW but also some local authorities and the steepening of the curve means that the long end is attractive for investors. On the recent Quebec deal, around 55% was sold to life insurers in France."
Living side by side
Tapping different maturities is not the only tool that public sector issuers have had at their disposal. Their access to a slightly different investor base has meant that the two asset classes have been able to live side by side and not cannibalise each other too much.
"The government guaranteed issues have found an investor base in the form of bank treasuries while central banks and agencies who have been key to SSA issuers in the past remain key to deals," says BNP Paribass Egan.
Indeed, bank treasuries have tended to buy at least half if not more of the government guaranteed bank bonds while they are likely to take around 30%-40% for traditional public sector agencies. The latter have been able to rely more on so called "real money" accounts, such as pension funds and insurance companies.
"The feedback we have received from the Dutch institutional investors is that three out of four are not buying this government guaranteed paper," says BNGs Van Dooren. "One of the reasons that they have given us is that with the strong participation of bank treasuries in these issuers, they are not sure of how they will perform and whether they will keep the bonds on their books. The other reason why institutional investors have been reluctant to buy these government guaranteed bonds is that they do not offer enough liquidity. Given that they run portfolios of billions, they want to be able to get in and out of positions quickly."
With conditions now having settled for both traditional public sector agencies and government guaranteed issuers, spreads have began to improve. Indeed, levels have stabilised and even tightened and although it is too early to say whether the rally will be short-lived, there was some optimism as this review was going to press in early May.
"What has been positive in recent weeks is the temporary stabilisation of spreads and in particular the strong performance of the three and five year part of the curve while 10 year spreads have stopped moving wider," says Rentenbanks Goebel.
"This, added to some active buying from investors makes us believe that there is a renewal of appetite for triple-A product. While it might be too early to say whether this is a change in the direction in the market, it is nonetheless encouraging."