Like the world's medical profession worrying about the population's tendency towards obesity, some bankers are concerned that big deals may damage the health of the international bond market. Are the days of the jumbo benchmark numbered? Jo Richards speaks to two borrowers with big financing needs about their borrowing strategies for the coming year.
When Fannie Mae raised the size barrier in the dollar market in 1998 by issuing a $4bn five year bond — the largest single tranche fixed rate transaction at the time — the term 'big is beautiful', was born.
For the next few years, sovereigns, supranationals and agencies (SSAs) with large funding programmes were able to raise swathes of their financing in one fell swoop and the bigger and therefore more liquid the issue, the tighter the spreads this asset class was able to command.
But the emphasis on size has diminished as volatility and underperformance of jumbo transactions have forced borrowers to be more cautious in their approach to the market, which in many cases has meant more modest issue sizes.
The situation has become worse this year as yields remain at rock bottom levels.
"There were times last year during the strong market rally that started in June when big deals were working well," says Sean Taor, head of frequent borrower syndicate at Barclays Capital in London. "But yields are now so low — 10 year yields are below 4.10% — that investors do not want to take big percentages of issues. They expect yields to rise between now and the end of the year and do not want to be caught out like they were in 2004 when 10 year Treasuries fell through 3.80% then retraced back above 4.80%."
Because of the perceived upward trend in rates, Asian central banks are typically no longer buying big clips of $300m or $500m in a particular deal. Taor says they are more likely to buy $40m or $50m.
"That is why in this market big deals are not necessarily what investors want," he says. "They don't care if the market bid isn't there for $300m because they only have $50m to sell so are happy with the liquidity offered by a $1bn or $1.5bn issue. They don't necessarily need big benchmark, super-liquid deals at the moment."
Performance and distribution are at the top of investors' lists of priorities these days and smaller deals have in many cases outperformed their larger counterparts.
"There was definitely a move a few years ago on the part of some supranationals and international agencies to emulate US agency liquidity in the dollar market," says Chris Lees, head of frequent borrower syndicate at Citigroup in London.
"However, as the trading levels of those sectors became increasingly dislocated from each other, comparable liquidity became less of an issue. It was more important for issuers and investors to feel that a deal had good primary distribution as that would have a better impact on long term liquidity and performance than size alone. Poorly placed large transactions have a higher potential to underperform. As a result, investors tend to have more confidence in buying smaller deals which they feel are more likely to be fully placed."
Transactions from the likes of Nordic Investment Bank, International Finance Corp, Inter-American Development Bank, Instituto Credito Oficial, Eksportfinans, Depfa and Rentenbank, which issue once or twice a year in the dollar market, are those prized by the investor community. And these issuers can command similar, if not better terms, than the more frequent borrowers.
IFC's annual visit to the dollar market at the end of April was a prime example. The book for the $1bn five year deal reached $1.8bn in a matter of hours.
The borrower achieved a spread of 22.5bp through Libor, in line with the EIB and well through Freddie Mac and Fannie Mae trading at 16.5bp through and 13bp through, respectively.
"IFC is extremely rare, accessing the public market just once a year," said a triple-A bond fund manager at the time. "Its June 2009 issue trades around Libor less 36bp and the new deal came at plus 23bp so it is a well priced offering for a fantastic name. It couldn't fail."
NIB achieved a level of Libor less 23bp when it issued a $1bn five year global bond in February. And Spanish agency ICO executed a $1.25bn September 2008 Eurobond in April at 35bp over Treasuries, or Libor less 19.5bp, the tightest spread achieved by a Spanish agency.
Dollar loses its drive
One of the reasons big SSA dollar deals are harder to place is the muted enthusiasm from investors outside Asia for dollar assets.
"The Asian central banks have broadened their horizons and now invest more in euros and other currencies but they are still the mainstay of the SSA market in dollars," says Allegra Berman, head of frequent borrower origination at UBS in London. "The problem is finding other buyers. European investors for the most part are negative on the dollar currency and do not drive dollar deals. And while the North American investor base is becoming more involved as the US agencies tighten more to Libor, they are still reluctant to take big tickets in names with which they are often not so familiar."
The Republic of Italy is the exception to the rule. The sovereign's $4bn 10 year deal, launched in January, is the largest 10 year fixed rate bond from this asset class in the dollar market. The issue was initially launched at $2bn but was doubled in size and priced inside guidance as investors worldwide bought into it.
But Italy can afford to issue at relatively cheap levels — its only criteria being to beat its domestic funding costs — and, at 37bp over Treasuries, this bond was priced in line with US agencies, and therefore appealed to the US investor base, which bought 47% of the paper.
While borrowers such as the NIB and IFC can afford to issue infrequently and in small size, as their annual funding requirements are in the $2bn-$5bn range, the European Investment Bank and KfW, both with targets of Eu50bn-Eu55bn each year, need to issue larger transactions otherwise they would be tapping the markets every month.
Frank Czichowski, KfW's treasurer, tells EuroWeek that while KfW remains committed to regular issuance in the dollar market in different maturities, he believes a better approach is not to insist on a specific size but to remain flexible and react to investor demand.
As a result, KfW has amended its programmes in both dollars and euros. "The amount we issue in maturities up to and including five years is now a minimum of $2bn rather than $3bn, and beyond that our minimum issue size is $1bn. In euros, the minimum size is Eu3bn across the whole curve," he says.
Czichowski believes KfW's new strategy is a success.
"We issued a three year benchmark transaction in January where we raised $3bn. Recently we issued a five year, which had a volume of $2bn," he says. "I think the concept worked well. Both transactions were oversubscribed and traded well, with good secondary market trading and a positive performance for investors. At the end of the day, we need to ensure that investors have a good perception of these transactions."
Bankers praise KfW for its pragmatic approach to the dollar market.
Commenting on the borrower's five year global bond issued in April, Ralph Berlowitz, head of frequent borrower syndicate at Deutsche Bank, says: "Since KfW and the EIB priced their five year deals in January 2004, which were difficult transactions, many underwriters have been advising both issuers to reduce the minimum size of their dollar globals from $3bn to $2bn because the market is sometimes just not deep enough at the pricing levels these borrowers command.
"KfW reflected the banks' advice when it announced its borrowing programme last December and reduced the minimum size for global deals up to five years to $2bn as they wanted to have deals which were fully placed at pricing. The recent five year global is a good example. The market was not deep enough at the time for $3bn so KfW priced a very successful $2bn deal which went bid only in the secondary market. It was probably the best five year deal we have seen for a long time."
Czichowski says that even in difficult markets KfW has to issue. "We cannot close our funding programme when the going gets tough," he says. "We have to issue whatever the environment but obviously without destroying our franchise. We do this by maintaining flexibility and deciding at the time of launching a deal how much the market can digest at a particular point in time."
Unlike KfW, the EIB does not specify size parameters but announces deals of benchmark size in certain maturities.
"We have issued three global bonds in 2005, two with three year maturities and one with five, and all have been $3bn," says Barbara Bargagli-Petrucci, head of the EIB's capital markets department in Luxembourg. "But we never make a statement on the size of any of our transactions — it is a matter of issuing deals to respond to specific demand, rather than achieving a particular size.
"We do deals when there is a window. Last year for example we issued a 10 year in May and were quickly followed by the EBRD and Austria. There we had a book of over $2bn and sized the deal at $1.5bn. What we do is go through our order book, look at the quality of orders and then make a decision on size."
EIB has been criticised recently for its strategy in dollars, some bankers feeling that the supranational forces large issues into an unreceptive market. Its $3bn three year bond launched in May, for example, was not fully sold at pricing, leaving lead managers with residual bonds and a percentage of loose bonds being traded in the broker market.
Citigroup's Lees believes that the EIB is one of the few borrowers that can access the dollar market in size.
"The EIB has an incredible dollar franchise," he says. "Their track record is also phenomenal and as a result investors have faith that every issue they launch will outperform the market. This gives investors added confidence when they commit to their transactions."
Fertile euro market
While the dollar sector favours smaller transactions, the euro market remains a fertile funding source for the sovereign, supra and agency asset class.
Deals by sovereigns such as Italy, Spain, France and Greece, all of which have chosen the syndicated method of selling their government bonds to achieve broad distribution and tighter issue spreads, have been overwhelmed with demand.
When Italy issued an Eu8bn 15 year bond in March 2004, for example, the book reached Eu15bn and, more recently, Spain's 30 year bond garnered orders of Eu17bn before being sized at Eu6bn.
The EIB and KfW are also able to offer larger bonds in euros than in dollars, but the cost to these Libor-based borrowers is punitive in the euro market. EIB, for example, can raise five year dollars at around Libor less 19bp all-in, while in euros, the cost would be Euribor less 3bp all-in (dollar Libor less 4bp).
In the belief that markets would remain volatile in 2005, KfW reacted by also changing its benchmark programme in euros. "Because demand for interest rate product may not be as deep as it is in a bull market, we reacted by amending our euro programme as well as dollars," says KfW's Czichowski. "We felt it was best to be a bit more flexible and favour placement over size."
To that end, KfW has changed the minimum size of its euro issues to Eu3bn across the curve. Its previous parameters were Eu5bn up to five years and Eu3bn for the longer dates.
"This year we have issued a Eu4bn 10 year bond off the programme and so far we have not issued a deal size in three or five years below Eu5bn," he says.
Similarly, in the euro market, the EIB does not announce in advance any size targets nor any tentative issuance calendar. "Our issuance in terms of timing and size is guided by a market-driven approach. We always aim to size our Euro Area Reference Notes (EARNs) to prevailing investor demand," says Bargagli-Petrucci.
When the borrower launched its first 15 year bond in 2004, a size of Eu3bn had been judged appropriate for what was the first super-long bond by a supranational. A book of Eu7bn required an increase to Eu4bn. "An increase to Eu4bn was needed to fill the top quality orders in the book," says EIB's Bargagli-Petrucci. "The book was top quality and we did not want to scale these clients back and create a technical trading level."
But the 2020 issue pales into insignificance when compared to the volume of orders the EIB received for its 2037 issue launched in May. Again Eu3bn was thought appropriate for such a pioneering trade but orders flooded in, bringing the book size to Eu11bn, and the issue was launched at Eu5bn.
Bargagli-Petrucci says the outcome exceeded expectations in terms of volume and the speed at which the book built.
"The books opened on Monday morning London time and closed 36 hours later," she says. "After reaching close to Eu8bn on day one, the total order book closed on Tuesday afternoon at over Eu11bn, more than twice oversubscribed relative to the final deal size. This is the largest order book ever for an EIB transaction."