Frequent issuers had braced themselves for a difficult year at the beginning of 2004, but it started off even worse than expected. However, as sentiment became less bearish and a clear direction returned, windows of opportunity opened, and the most successful borrowers in 2004 were those that were nimble enough to leap through them. Neil Day reports.
At the end of 2004 the feeling among frequent issuers in the dollar market and the debt capital markets and syndicate officials covering them was one of relief. What had looked like being a bad year proved to be challenging, but ultimately rewarding.
A $3bn five year deal for the European Investment Bank in January gave the first clear signal that all was not going to be easy. Led by Citigroup, Goldman Sachs and UBS, the deal struggled at its pricing of around 22bp through mid-swaps.
Although the transaction was dubbed aggressive, the main problem was not so much any greed on the part of the EIB, but the lack of appetite for five year dollar paper, particularly from Asia. More evidence of this emerged the following week when KfW had difficulty selling another $3bn five year deal via JP Morgan, Lehman Brothers and Morgan Stanley.
?The main reason for the tough start to the year was that virtually everybody in the market had the view that over the course of 2004 yields would be rising, and investors therefore didn't have the typical enthusiasm to put money to work,? says Scott Lampard, head of frequent borrowers at JP Morgan in London.
The Republic of Italy dug up some appetite at the short end of the curve when it priced a $2bn tap of its $3bn December 2006 benchmark through Deutsche Bank, Goldman Sachs and Merrill Lynch in the first week of the year.
?Clearly the most successful dollar deal of the week,? said one syndicate official, ?highlighting the concentration of investors on the short end of the curve in this currency.?
Italy read the market correctly again when it returned in late February with a $2bn five year issue. Led by Credit Suisse First Boston, JP Morgan and Lehman Brothers, the deal was much more smoothly absorbed than were the EIB's or KfW's five year deals in January ? although those, too, had begun to perform better in the secondary market as sentiment started to shift.
?Going into March, yields had hit something of a plâteau, at their lowest levels and investors began extending duration back out into the five year sector,? says one origination official reviewing the first half of the year. ?You then saw two and three year paper, which had been rich to Libor, cheapen up, and the 2009 paper, like the EIB and KfW issues, then started to perform against swaps. And the next few issues that came in five years ? Finland, the Nordic Investment Bank and International Finance Corp ? were some of the best received deals of the year.?
Such was the revival of appetite for five year paper that in the week after Italy's trade, the Republic of Finland was able to execute a successful deal in the maturity. Finland sold a $1.5bn May 2009 Eurodollar via Barclays Capital, Citigroup and JP Morgan that, boosted by the republic's rarity value, secured the sovereign cheap funding.
?The cost-effectiveness of the issue in dollars was a lot better than it would have been in euros,? said Ari-Pekka Latti, deputy director of Finland's state treasury's front office. ?For the same maturity, we would have achieved Euribor minus 10bp ? while here the cost was the mid-20s under Libor.?
Shortly afterwards the Nordic Investment Bank demonstrated its strength in the global dollar market by pricing a $1bn five year transaction at around 22bp through mid-swaps, inside some credits that are more established in the sector. Led by Citigroup and Nomura, the deal was heavily bought by Asian central banks.
NIB's profile and issuance strategy continued to draw comparisons with the International Finance Corp, which itself reaffirmed its position at the top of the market with a $1bn five year deal via JP Morgan and Nomura in April. Its quality and rarity meant that the deal was twice oversubscribed at an attractive level for the IFC.
?We achieved an after-swap cost of Libor less mid-20s and excellent distribution, with roughly 40% sold in Asia, 31% in the US and 29% in Europe and the Middle East,? said Nina Shapiro, IFC's vice president of finance and treasury in Washington.
As well as the growth in demand for five year assets, another factor in the success of Italy's late February transaction that was not present in either the EIB's or KfW's January issues was a spread comparable to US agencies.
Italy's pricing of about 8bp through mid-swaps was not far below the level at which Fannie Mae was trading at that time. And while investors have increasingly viewed diversifying away from the US government sponsored enterprises as a strategy they are willing to pay up for, it is easier for US accounts to make the shift when they have to sacrifice fewer basis points to do so.
This shift towards diversity, combined with reduced dollar benchmark issuance from supranationals ? such as the World Bank, which again only raised $1bn in 2004, and the Inter-American Development Bank, which cut back from $3bn to $1bn ? has allowed a richer variety of borrowers to access the US investor base via global bonds.
Swedish Export Credit (SEK), for example, launched its second dollar global in December, a $1bn January 2008 issue via Citigroup, Daiwa and Lehman Brothers, and was able to sell half the deal into the US.
SEK had, according to Per Åkerlind, CFO and head of capital markets, been considering the three and five year maturities, but opted for the shorter tenor to give a better relative spread to GSEs and thereby ensure a strong US following, while at the same time achieving a competitive funding level.
?It was important to achieve a deep distribution into the US,? he said. ?We have been trying to build an investor base in global bonds. The driving force of last year's transaction was the US investor base, where 54% of our issue was placed.
?Had we come in five years we would have issued many basis points through agencies, whereas this issue is flat to slightly through.?
The issue was priced at 30bp over US Treasuries, equivalent to Libor less 14bp, which was flat to marginally wider than comparable US agency names in three years. ?Investors like the credit,? said a Citigroup syndicate official, ?but crucially it is able to come at a workable price relative to agencies and that enables the transaction to have genuine global appeal.?
SEK's December deal came only two weeks after its Norwegian peer, Eksportfinans, had sold 40% of its second global bond ? also a $1bn January 2008 issue ? in the US, after placing 37% of its $1bn five year debut stateside in June.
An official at Goldman Sachs ? joint books with Citigroup and Nomura on the first trade and with Morgan Stanley and UBS on the second ? put the strong US sales down to two factors.
?First, the marketing that Eksportfinans has done in the US, and second, the way in which offering a spread comparable to the US agencies is still an invaluable carrot for US accounts,? he said.
Eksportfinans came at 11bp through mid-swaps when Fannie Mae's December 2007s were trading at minus 11bp and Freddie Mac's May 2007s at minus 16bp. And while US investors were happy with the pricing, so was Eksportfinans.
?When we came into this year we had never launched a benchmark issue at a sub-Libor level,? said Søren Elbech, head of funding and debt investor relations at Eksportfinans. ?We worked very hard on preparing the way for this possibility ? we believed it was the natural next step for us.
?We then did the five year global in June and ended up healthily through Libor, in the low single-digits, and the performance of that deal has since shown that we priced it correctly. But now, being able to price a benchmark in the double-digits through Libor, is flabbergasting. It shows that our funding strategy of the last couple of years has paid off.?
Calling the Treasury market
While attractive pricing versus agencies stimulated US demand, issuers still had to read the market right. When Italy did so with its five year in February, for example, it was spotting a shift in ? or at least greater certainty about ? the interest rate outlook.
?There was a tremendous amount of uncertainly about the direction of interest rates and although that still exists, more and more investors feel the Fed will be true to its word and not hike rates soon,? said one banker involved in the Italy transaction.
However, finding opportunities when there was uncertainty about the direction of interest rates was not easy, especially in the first half of the year.
?Investor demand was patchy at many times in the year because people were nervous,? says Allegra Berman, head of frequent borrower origination at UBS in London. ?They'd wait for a piece of data, and that would be inconclusive. Or one day you'd get a number that was inflationary, and the next day you'd get another number that wasn't so inflationary, and investors wouldn't know where the market was going.?
As the year wore on and the market enjoyed several strong rallies, investors became just as worried about being underweight a rising market as they were of being exposed when the market turned bearish.
?The market would begin to rally strongly and because investors were worried that they were going to miss out they'd pour in,? says one DCM official. ?In 10 years, for example, where yields moved around a lot, there would be investors that didn't want to buy at, say, 4.04% or 4.05%, but then as soon as it went through 4% to 3.99% they'd pile in. You'd therefore have people who would buy at 4.20%, not at 4.05% and might buy at 3.95% because they were chasing the market.?
Hitting the correct window was no mean feat. ?Last year it was important to be able to respond quickly to demand and not get locked into a particular transaction too far in advance, because you never knew from one minute to the next what investors were going to be doing,? says one syndicate head.
NIB timed the market well with its $1bn five year global. ?What I particularly like about the issue is that everyone saw the market rally after the FOMC and assumed that it would be negative for the bond market,? said one banker involved in the deal. ?In fact it has been incredibly positive as short dated yields are so low, accounts are pushing out on tenor and are willing to take duration risk, which worked in favour of NIB's transaction.?
A month later, in mid-April, Landwirt-schaftliche Rentenbank showed similarly clever timing with a $1bn five year issue led by BNP Paribas, JP Morgan and Morgan Stanley. ?Yields have backed up, swap spreads are wider and investors are still very underweight the dollar sector,? said one syndicate official away from the leads, ?and, even if they are still negative about the market, this is an excellent opportunity for them to put their money to work.?
Elusive sweet spots
However, sometimes deals still struggled even when the timing looked right. An example was a $1bn five year Eurodollar for Bank Nederlandse Gemeenten (BNG), the Dutch municipal bank, launched by Goldman Sachs, Nomura and Royal Bank of Scotland in mid-May.
The deal struggled in spite of being launched after a Treasury sell-off sparked by stronger than expected US employment data. The figures may have pushed yields higher and prompted stronger demand, but the consensus remained that investors were shying away from five years in a bear flattening market.
?Demand for US dollar assets remains healthy,? said one banker at the time, ?but the sweet spots seem to be either two or three years, or seven to 10 years. Investors have been avoiding the belly of the curve, as evidenced by the recent ICO five year transaction, which was not fully sold and is still available.?
Unfortunately for BNG, its deal marked the end to a run of five year demand that had begun to peter out with the $1bn five year issue for Spain's Instituto de Crédito Oficial (ICO) in late April. Bankers had said that the issue, led by ABN Amro, BNP Paribas and Citigroup, had not only been on the aggressive side, but had come too late.
The World Bank also found timing tough in mid-June when it brought its only dollar global of the year. Citigroup, Daiwa and Morgan Stanley launched the $1bn five year issue into strong Asian demand after yields had risen sharply in April and May, but the market's more recent direction was a cause for concern. ?The timing is questionable,? said one banker. ?To open the books the day after the market rallied 20bp did not make sense to me.?
EIB gets its timing right
The deal that capitalised best on April's sharp rise in yields was a 10 year global bond for the EIB, which proved to be one of the best timed transactions of the year.
The borrower approached the market cautiously at the end of April with a relatively modest $1bn size, aware of the difficult market conditions and how far it was pricing through US agencies. However, leads JP Morgan, Morgan Stanley and UBS built a book of over $2bn and priced a $1.5bn deal at 22bp over the February 2014 Treasury, equivalent to 23.5bp through mid-swaps.
The EIB's issue was the first real 10 year benchmark of 2004. One reason for the lack of supply in the maturity had been the tight levels at which secondary paper was trading ? the EIB's old benchmark, its 2013, for example, traded as tight as 45bp through Libor. It was still trading in the 40s through when the EIB priced its new issue at a more realistic level.
?It was always going to be difficult being the first one into that market, but the EIB got the timing and approach right,? said one banker. ?They had to pay a premium and they did so, and they thereby opened up the market and showed that people are more comfortable with the yield outlook.?
In the month before launch, 10 year Treasury yields had risen around 100bp to nearly 4.75%, tempting investors along the curve. ?Market conditions have changed in the past few weeks,? said James Garvey, head of the European frequent borrowers group at Goldman Sachs in London. ?Investors can buy triple-A assets above 5% in 10 years and many are now reassessing their yield and duration targets.?
Transactions for the European Bank for Reconstruction & Development (EBRD) and Austria in the first half of May added further supply to the maturity, but the reception they enjoyed was far from equal to the EIB.
The EBRD announced its deal first, a $1bn trade via Citigroup, Daiwa and Deutsche Bank, after the April non-farm payroll data had pushed the yield on the 10 year Treasury above 4.75% for the first time in almost two years, making a 5% coupon possible. However, the supranational's chances of success were hit when Austria announced a similarly sized deal in the same maturity via Barclays Capital, CSFB and Goldman Sachs.
Any hopes either borrower had of playing into the same demand that the EIB had uncovered were dashed. The market was increasingly unsteady and their pricing was less sensitive than the EIB's.
?The market is too volatile to absorb $2bn of 10 year supply in a couple of days,? said one syndicate manager. ?The EBRD did much better than Austria, mainly because of its rarity and the possibility that it may not appear again for another three years.?
As the middle of the year approached, investors became cautious again and while the World Bank struggled with its five year trade in mid-June, the EIB called the market well, this time with a rare two year global bond.
Citigroup, Deutsche Bank and JP Morgan won the mandate for the issue on the Monday and the deal was oversubscribed by pricing two days later. Bankers praised the EIB for its flexibility in responding quickly to investors' needs, as it had done in April with its 10 year global.
?Flexibility is a key part of our funding strategy and the ability to be nimble has been particularly important this year,? said Sandeep Dhawan, senior capital markets officer at the EIB in Luxembourg. ?The market has been difficult to call, particularly in dollars.?
Before the EIB's transaction, non-farm payroll numbers for March to May had been released, showing the three months to be the strongest period for job creation since May 2000. This had confirmed investors' expectations that the Federal Open Market Committee would raise interest rates from 1% at the end of June, giving them the certainty that had previously been lacking and convincing them to commit funds to the bond market.
The following week, on June 15, Federal Reserve chairman Alan Greenspan gave Congressional testimony in which he indicated that interest rate increases would be gradual, and the market correctly moved from being unsure whether to expect a 25bp or 50bp rate hike to a consensus that a 25bp rise would occur.
Over the rest of the year interest rates rose by 25bp at each FOMC meeting to reach 2%, but overall the market was less bearish than investors had feared at the beginning of the year. The direction of the market was now clear and from June to November the yield on the 10 year Treasury fell steadily.
Welcome back, Asia
This meant that market participants returning after the summer found the market much more accommodating, particularly because the difficult conditions earlier in the year had resulted in a lack of sovereign, supranational and agency supply.
Non-farm payroll figures released on the first Friday of September, which were in line with expectations, were the trigger for post-summer activity ? implying a mildly healthy outlook for the economy, they led to a slight rise in Treasury yields and a more stable market. The Inter-American Development Bank, the EIB and L-Bank offered $5bn of paper across the curve to investors keen to put their cash to work.
The IADB was keen to add a 10 year point to its curve and bookrunners CSFB, HSBC and Morgan Stanley delivered a successful issue in the maturity, pricing a $1bn trade after building a $1.4bn order book. The IADB pulled in an impressive 30% of orders from US accounts, despite coming 27bp inside GSEs.
However, it was Asian investors that were really back in force. They took 55% of the IADB's deal and 49% of the EIB's $3bn three year issue, led by Citigroup, Nomura and UBS. Demand for dollars then continued strongly through deals such as those for Eksportfinans and SEK as the year drew to an end.