No rest for KfW till Bund is caught
Kreditanstalt für Wiederaufbau's euro benchmark programme, launched this year, is just the latest move by the German development bank to position itself as close to the Bund as possible. The bonds have achieved high levels of liquidity, supported by the new EuroMTS trading platform. Replicating this success in the dollar market is one of KfW's aims for 2002.
Frank Czichowski, head of international capital markets at Kreditanstalt für Wiederaufbau (KfW), could be forgiven for leaning back, lighting a large cigar and settling in for an early and extended Christmas holiday. He deserves to, because by any yardstick the Frankfurt-based development bank has enjoyed an outstanding year in the international capital markets. Taking a few lessons from Freddie Mac, KfW launched the first bond in its euro denominated benchmark programme in March, a Eu5bn 10 year global led by Deutsche Bank, Schroder Salomon Smith Barney and UBS Warburg. Demand for this curtain-raiser was close to Eu10bn, allowing the transaction to be priced through a comparable Italian government bond, or at 45bp over Bunds.
March's offering was followed up, in accordance with KfW's pledge to the market, with another Eu5bn issue, this time with a five year maturity via Dresdner Kleinwort Wasserstein, Goldman Sachs and Morgan Stanley. Once again the transaction was hugely oversubscribed, paving the way for the unofficial spread talk to be revised downwards, with eventual pricing of 27bp over the February 2006 Bobl - through Belgium and Spain and only a basis point or two shy of Austrian government paper.
Encouraged by the success of these transactions, KfW announced in September that it would expand the yield curve in its benchmark programme further still this year, with an additional Eu5bn three year offering via Deutsche, JP Morgan and Merrill Lynch. This decision was made well before the September 11 attacks in the US, which only served to increase demand for shorter dated triple-A quality paper. The transaction went ahead in October as scheduled, priced at 16bp over the November 2004 Bobl.
Over and above that, the bank has indicated that in 2002 the size of the programme will be at least Eu15bn. "We are committed to doing five and 10 year transactions of at least Eu5bn in 2002," says Czichowski. "How we will fill the other Eu5bn has been left open. We could either issue an additional Eu5bn in a different maturity, as we are doing with the three year deal this year, or we could increase the size of outstanding issues."
The two euro benchmark transactions launched by KfW in March and July were successfully marketed as government surrogates. "Our major aim in marketing the euro benchmark programme has been to promote more interest in our bonds from traditional government bond buyers and to present KfW as an undervalued Bund, or as a Bund with a yield pick-up," says Czichowski.
This strategy appears to have paid solid dividends. Czichowski says that the majority of the 350 or so accounts that applied for either or both issues were traditional government bond investors and that as a result KfW's investor base is incalculably more internationally diversified now than it was two or three years ago.
Others agree. "The euro benchmark programme has essentially moved KfW out of the world of credit markets and into government territory," says Philip Brown, managing director of the debt syndicate at Schroder Salomon Smith Barney in London. "But it is new to the world of government surrogates and there is still a tremendous opportunity for KfW to grow its position within the portfolio of government bond investors worldwide. As recognition of the liquidity of the product grows, we will start to see continued outperformance of KfW's bonds, which will in turn create a virtuous circle bringing in even more investors."
That would dovetail neatly with Czichowski's own ambitions, which he describes very succinctly when asked whether anything else could be done by KfW to reduce its borrowing costs further still. "As long as we pay more than the Bund, there will still be a long way to go," he says.
Of course there are a few reasons why for the time being KfW can only hope to diminish the funding gap with the Bund, rather than to close it altogether. As Brown points out, these include the facts that KfW is not deliverable into the Bund future and that it does not feature in government indices, both of which will ultimately put a cap on the spread narrowing between the development bank and the German government. "Maybe those are both substantial reasons for the spread," says Brown, "but I don't think they should account for more than about 10bp. There are plenty of grounds for optimism about the potential for KfW to close its spread to Germany and other European governments further still. For example, in the 10 year benchmark KfW is trading at 25bp over Bunds, whereas Holland is at 15bp over. It is not unreasonable to believe that KfW could reduce that spread over Dutch government bonds considerably."
In terms of liquidity, two further recent developments have helped KfW in the euro denominated market. The first was the merger with Deutsche Ausgleichsbank (DtA), which has substantially increased its overall funding requirement to somewhere in the region of Eu40bn annually.
The second development that has played an important role in the enhancement of KfW's liquidity has been the smooth launch and subsequent healthy development of the EuroMTS electronic trading platform on which the bank's benchmark bonds are traded. "We have been extremely satisfied with the liquidity that has been provided by the system," says Czichowski. "It is a very helpful tool for providing investors with the assurance that the bonds they hold are very liquid, and it has translated into most houses quoting KfW bonds at a very tight bid/offer spread in the secondary market. But we are also very actively traded on some of the proprietary systems, such as Deutsche Bank's Autobahn, and we are told that we are trading on that system in very big blocks, which is encouraging."
The outstandingly high levels of liquidity in KfW's euro denominated bonds have not, to date, been replicated in the dollar market, which has been an immensely important source of funding for KfW this year. Indeed, Czichowski points out that when the bank launched its most recent $2bn three year deal it took KfW's total funding in the dollar market in 2001 to the equivalent of about Eu12.5bn. "That is a sizeable amount and at the time it surpassed what we had raised in euros," he says, "although our announced Eu5bn three year deal will mean that for the year as a whole the euro will be our most important funding currency."
Nevertheless, the sheer amounts that KfW has raised in the US market mean that Czichowski would warmly support any measures that would bolster KfW's liquidity in dollars. "Trading to date has not been as active in dollars as it is in euros, and in that market we would welcome initiatives to provide the same sort of liquidity in the interbank or inter-dealer market that has been provided by EuroMTS," he says. "Providing more liquidity in dollars is clearly going to be an important part of our agenda in 2002." *