Despite Germany's economic and political uncertainty, international investors' love affair with German top tier credits is as strong as ever. With its first foreign currency bond for more than 50 years, the government attracted a whopping $14bn of demand, while the country's triple-A borrowers, spotting the need to be more flexible, have reaffirmed their popularity with a series of blowout deals. Philip Moore reports.
For the cream of Germany's borrowers, neither the fragility of the domestic economy nor the political uncertainty arising from September's nail-biting election have had much effect on investors' enthusiasm for their bond issues.
The most prominent and most eagerly-awaited of those borrowers, of course, has been the government itself via the Finanzagentur, which in May launched its first foreign currency bond for more than 50 years. That $5bn five year transaction, led by Deutsche Bank, Morgan Stanley and Goldman Sachs, was a blowout, generating $14bn of demand in a day and allowing the price range to be revised from a mid-teens spread over US Treasuries to between 12bp and 15bp. Of those orders, $11bn held firm when the re-offer spread was set at the bottom of the range.
"Our experience with the dollar deal was excellent, especially with regard to the allocation of the bonds both by region and institution, which was exactly in line with our target," says Gerhard Schleif, managing director of the Finanzagentur.
What was less satisfying for Schleif and his team was the bond's performance in the aftermarket, which the Finanzagentur was powerless to influence. "For us that was a new experience, because we are active in the secondary market for the bonds that we sell via auction," says Schleif. "In future transactions we will certainly look at
alternative ways of handling the secondary market."
Those transactions are already in the pipeline. It is an open secret, for example, that the Finanzagentur's next syndicated benchmark bond will be an inflation-linked instrument, which could surface as early as before Christmas, although the first quarter of 2006 is more likely.
For the German government to endorse inflation-linked bonds is something of a special challenge, given that inflation has been economic public enemy number one since the late 1940s and the success the Bundesbank has enjoyed in battling against it.
"The argument in this country has traditionally been, why should we need instruments that protect against inflation when we have been so successful in fighting inflation," says Schleif. "I think there are no more than three local mutual fund companies that are allowed to invest in inflation-linked bonds, while insurance companies in Germany don't offer their clients products that protect them against inflation."
Against that backdrop, persuading domestic institutions to buy into the inflation-linked argument will inevitably call for a highly effective marketing effort.
That is one reason why the Finanzagentur will not be selling its debut linker through its traditional auction mechanism. "One reason why we have said that we will have to sell the linkers via a syndicate is that we don't know the investor base," says Schleif.
Beyond the linker market, the Finanzagentur has a number of options as it explores alternative ways of reducing its overall borrowing costs. Options might include an MTN programme and internationally sold Schuldscheine.
"We are looking at a number of ways of diversifying our funding toolbox, such as tapping additional currencies," says Schleif. "The problem of foreign currency markets is that we can't run any currency risk, so we will always need liquid currency swap markets."
Flexibility is also the watchword for other German triple-A borrowers. KfW, for example, has made its borrowing strategy more adaptable.
"We announced at the start of this year that we would be pursuing a more flexible approach to our benchmark strategy which has proved to be very popular with investors," says Horst Seissinger, first vice president of capital markets at KfW's Frankfurt headquarters.
"We said that we recognised that markets are no longer necessarily capable of absorbing Eu5bn immediately, and that we would be factoring that into our benchmark borrowing strategy in 2005."
That, adds Seissinger, has not meant that Eu5bn transactions have not been possible this year. Quite the reverse. KfW's most recent three year euro denominated benchmark led in September, by Citigroup, BNP Paribas and Lehman Brothers, started out as a Eu3bn deal. "As with our previous transactions, the goal was to build up an oversubscribed book which would allow the bonds to outperform," he says.
"After a relatively modest start on the Monday, the order book exploded to Eu7bn on the Tuesday, allowing us to increase the transaction to Eu5bn,
which was seen as the benchmark size two years ago."
While KfW will be happy enough to repeat that particular exercise in 2006 and provide investors with jumbo offerings if they are demanded, the likelihood is that its borrowing programme will be characterised by smaller benchmarks. That is even more applicable in the dollar market — in which KfW will have launched three benchmarks in 2005 compared with two in 2004 — than it is in euros.
"The feedback we have had from investors in the dollar market is that they would prefer to see us in the market more often than with benchmarks of $4bn," says Seissinger.
Increased flexibility has also been the Leitmotif underpinning KfW's more opportunistic issuance in 2005. By early October the bank had printed close to 500 trades for the year, which means it will comfortably exceed 2004's number. Rather than reflecting any increase in KfW's overall borrowing requirement — which remains stable at around Eu50bn — it shows a reduction in the minimum size of the bank's individual transactions in markets such as yen, which has been revised from ¥1bn to ¥500m.
It also shows a reflection of an increase in KfW's issuance of structured euro denominated issuance in 2005, and of an expansion of its activities in a selection of emerging currencies ranging from Turkish lira and Mexican pesos to Hungarian forints and Icelandic krónur which, says Seissinger, have inevitably captured the imagination of the media.
"Demand for those currencies has obviously been fuelled by retail investors who are prepared to bear the currency risk for the yield pick-up," Seissinger adds. "We are happy to tap into those markets when there is investor demand, but our main priority beyond the core euro and dollar sectors is to continue to build our reputation in markets where we see consistently strong domestic demand such as the yen, sterling, Swiss franc and Australian dollar markets."
Focus on flexibility
For Rentenbank, the other Frankfurt-based triple-A rated public sector bank which is a regular borrower in the international capital market, the focus in recent years has also been on flexibility. "We never saw the merits of an issuance calendar with formalised schedules for benchmark issuance," says Horst Reinhardt, Rentenbank's treasurer. "In the last few years we've seen some borrowers back-pedalling from their official calendars, which suggests that we were right in maintaining flexibility in our borrowing programme."
Clearly, with an annual borrowing requirement of about Eu10bn, Rentenbank has more room than some of Europe's more prolific triple-A borrowers to be flexible about the timing of its issuance. But it also inevitably limits the amount Rentenbank is able to raise from benchmark transactions, which typically account for about 40% of its annual funding.
"To achieve primary distribution of the highest quality we try to limit the size of our benchmark transactions," says Reinhardt. "The minimum size is $1bn or Eu1bn and we are only inclined to increase the size of transactions if that is fully supported by the size and quality of the order book. That leads to a situation where the levels of flowback in the secondary market are very low which is a good foundation for performance in the secondary market."
That was what happened in January, when Rentenbank launched its largest ever benchmark in euros via Citigroup, Deutsche Bank and HSBC. In response to a high quality order book, of which 99% was accounted for by cash orders, Rentenbank increased the size of this five year deal from Eu1bn to Eu1.25bn, but still achieved pricing of swaps less 3bp, the tightest level Rentenbank has ever commanded in euros.
Two months later, the borrower applied the same philosophy to the dollar market, increasing the size of its ninth global bond from $1bn to $1.25bn in response to the quality of the order book. Described by one bookrunner at the time as an "extraordinarily successful deal", this three year offering was led by Citigroup, DrKW and JP Morgan.
"Dollar benchmark funding has been especially cost-efficient for us this year, and it is probable that our last benchmark deal in 2005 will also be a dollar deal," says Reinhardt. "But we are also continuously looking to broaden the range of funding products and currencies that we use. The success of that diversification strategy has probably best been illustrated by our Australian dollar MTN programme. Almost 14% of our issuance this year has been in Kangaroo bonds, of which we have so far issued an aggregate of more than A$4bn, which makes us the largest issuer in the Kangaroo market."