European sovereign bond volume will fall in 2014 but will remain high by historical levels. Supranational and agency volumes are trickier to predict, but bankers are confident that the market can take any extra supply — despite some dealers paring back their SSA business.
With deficit reduction the focus of governments across the eurozone, one might be forgiven for thinking that sovereign funding volumes would decrease by a large margin this year. But gross issuance is set to be just €5bn-€6bn lower compared to 2013 at €853bn for the largest eight countries — France, Germany, Finland, Austria, Netherlands, Belgium, Italy and Spain — according to Vincent Chaigneau, global head of rates and FX research at Société Générale in Paris.
“Gross supply is being kept fairly high because of the heavy redemptions due that are fallout from the very large issuance and deficits we saw through the crisis,” he says.
“Gross issuance jumped from €536bn in 2007 — including Greece, Ireland and Portugal — to a peak of €947bn in 2010.”
Eurozone sovereigns — especially those in the periphery — had to rely on shorter dated paper as investors fretted over a potential break-up of the currency bloc.
The distorting effect on sovereigns’ redemption profiles can be seen in the case of Spain.
“We’re in the middle of a budget consolidation process,” says Pablo de Ramón-Laca, head of funding and debt management at the Spanish Treasury in Madrid.
“Net funding needs should fall but gross needs will remain high and may increase because of our redemptions. Last year we had €62bn of redemptions, this year they are about €68bn and next year will be €90bn.”
Many sovereign issuers are focused on pushing out their average maturities this year. But while demand has been strong over the last few quarters — remarkably so in the case of the periphery — printing longer dated debt will be a tougher sell.
“Sovereigns are now trying to lengthen their maturities and reduce the rollover ratio,” says Chaigneau at Société Générale.
“But demand at the long end is not so obvious. Over the last few quarters there was strong demand for short dated debt from the periphery because that’s where the carry roll down was. Investors have been hopeful that, should the crisis return, protection from the OMT and European Stability Mechanism would be activated.”
Despite these challenges, bankers are confident that after a long period of unpredictability, 2014 will be easier to forecast.
“Our working assumption in the last quarter of 2013 was that the market should behave smoothly over 2014 and that tapering would be well flagged,” says Sean Taor, head of European DCM at RBC Capital Markets in London.
“Despite some shocks along the way — volatility in emerging markets, a slowdown in China, Italian elections, and the conflict in Ukraine for instance — the market has been very resilient. Investors have responded well and so far the overall stability of the markets has been very welcome.”
Uncertain change
While sovereign volumes are set to decrease slightly, the picture is less clear for supranationals.
“Supranational volume is a difficult one to call if only because of the emerging market upheavals,” says Bill Northfield, head of SSA origination at Deutsche Bank in London.
“But as the Ukraine troubles have gone on we’ve had 12 or 13 emerging market sovereign deals in the first eight weeks of the year, which is great. If things flare up in other parts of the world supranationals might increase funding, but it’s probably flat to maybe minus 2% for them.”
Northfield also believes that investment grade agency borrowing will be down a few percentage points this year, although the figure is as high as between 25% and 30% for US agencies.
But at a granular level, the different forces compelling supranationals and agencies to print more or less paper are diverse.
“Supranational and agency supply increased a lot in 2009 because they were trying to contribute to global growth, along with governments,” says Jean-David Cirotteau, credit analyst at Société Générale in Paris.
“Many of them strongly increased their supply and even if some of them have pulled back slightly from those levels, they have maintained a similar pace of issuance since. This is quite evident with KfW and the European Investment Bank but also globally. The European Financial Stability Facility and ESM are being a bit less busy as the existing programmes are amortised or closed. But for some there are other dynamics at play. Unédic has been very busy, while Nordic municipal agencies have increased supply significantly over the last three or four years.”
Part of the increase in those Nordic agencies’ volumes has been driven by banks exiting another area of the financial business — local government loans.
“Banks have on the whole withdrawn or been priced out from the very low return, highly competitive local government funding sector,” says Stuart McGregor, head of European SSA DCM at RBC Capital Markets in London.
“This has seen many of the agencies’ business grow rapidly over the last five years, [as] the bigger loan books obviously lead to larger issuance programmes.”
But new sources of demand should help absorb any extra supply.
“Liquidity capital ratio developments are pushing some banks to look at balance sheets closely,” says Cirotteau at Société Générale.
“It’s creating good demand as most supranationals and agencies qualify as Level One assets. The LCR implementation, which starts from 2015, creates a strong bid for some of these issuers. It’s a little bit surprising. If you look at some of the studies available, they said there were already enough high quality assets in the market and the initial results from the LCR revealed that many banks were already above the required 100% threshold, even though they only have to be compliant by 2017 or 2018. But they tend to reallocate the composition of their liquidity buffer which leads to some adjustment.”
Cirotteau points to a €6bn March 2021 bond by the ESM in February — its first seven year print and its first new issue to be priced through the EIB’s curve — as evidence of this rebalancing. Banks snapped up 54% of the paper on offer.
Out of the game
However, some bankers worry that new regulations will have a detrimental effect elsewhere.
“One of the biggest issues for the industry overall is the capital banks employ in fixed income,” says RBC Capital Market’s Taor. “Capital Requirements Directive IV demands that banks hold more capital, so making banks more exacting of the business they’re in. We’ve seen some banks exit the market in selected sectors and other banks are also looking at their business to see whether the returns those businesses generate cover their cost of capital. It’s clearly going to be more challenging for the industry overall to maintain the current level of capital committed to the fixed income market. If a bank’s return on equity is below its cost of capital then that model is not going to always be justifiable or sustainable over the long term. One consequence will be a decline in secondary liquidity, making the new issue pricing process more challenging.”
Despite these concerns, issuers say they are happy with the level of service they receive.
“There’s more competition to provide a good service than before,” says de Ramón-Laca. “The landscape of investment banks is very fluid. Sometimes banks move out of a market but others move in. There is better competition in our primary dealer pool than in previous years, with greater willingness to compete in the secondary market and to provide more operations.”
But some bankers have encountered nervousness from issuers, particularly when dealers exit the SSA sector, like UBS in 2012, or others reduce headcounts on their SSA desks.
“Issuers are worried but they’ll never let you see them sweat,” says a senior SSA banker in London. “They’ll say they’re well banked but then quietly ask, ‘You’re still onside, right?’. A lot of these issuers need swap lines, they need derivatives and they need the balance sheet. They tell you they’re completely over-banked then beat you up for not giving them a better price. If they had been able to trade at a better price elsewhere, they should have dealt away.”
