A story of two halves
Despite higher funding requirements for many, most SSA issuers have managed to access the capital market with relative ease this year. Record sub-Libor spread levels at the end of summer 2008 gave way to spiraling funding costs, as the government-guaranteed market sprang to life, but spreads have been grinding back in and may even go full circle. Michael Winfield reports.
The EBRD was the first SSA issuer to push spreads back through Libor. That trend began in June and has continued since, helped by the fact that many borrowers are already a substantial way through their requirements. As the market reopened in September, new issue spreads were again contracting: the risk aversion trade at the beginning of the year looked increasingly like an historical aberration in the history of SSA debt issuance.
It was a nervous start to the year for the SSA sector. Participants understood that overall funding levels were likely to be higher for all capital market issuers. Many adopted a policy of borrowing as much as the markets would allow as quickly as possible, just in case there was a repetition of the previous year, when those issuers that spread their issuance lost out as capital diminished late in the year.
At the beginning of 2009 the first issuers to appear achieved relatively attractive levels of funding – albeit still largely reliant on the shorter end of the yield curve – despite the refinancing implications for forthcoming years. By late spring the early optimism had evaporated. Conditions deteriorated amid competition with burgeoning sovereign-guaranteed bank supply.
The EIB was amongst the first to test the waters in early January with a US$4.5bn three-year Global deal, priced at mid-swaps plus 20bp. In autumn 2008, before the shift in SSA pricing, a similar transaction was sold at mid-swaps less 40bp. Around the same time SFEF, the French state guaranteed entity created to support the banking sector, sold its third euro-denominated deal at mid-swaps plus 15bp – around 10bp wider than the two and three-year issues it had sold in 2008. These early trades attracted significant book sizes and suggested the worst of the buyers strike may have been over, as interest rates and equity markets declined. The Dow Jones Industrial Average fell from around 9,000 at the beginning of the year to 8,000 by mid-January, before selling off to just below 6,500 in early March.
By late January, when the EIB sold its first five-year deal of the year, not only had its cost of funding risen to mid-swaps plus 40bp but the issue only attracted US$2.7bn of interest for a US$2bn deal. As March came to a close, the EIB sold its second five-year Global which was, at US$3.5bn, it's largest to date, albeit at an eye-catching 85bp over mid-swaps or almost 140bp over US Treasuries. This deal and a five-year trade for KfW completed at mid-swaps plus 95bp, marking the wide point in the issuing cycle. The deals were made possible by stronger US account participation than had been seen in previous SSA deals – 59% of the EIB and 62% of the KfW deals went to the US.
"The level of the euro/US dollar basis swap acted to mitigate the cost of the high optical spreads being paid by issuers,” said PJ Bye, head of SSA syndicate at HSBC. “Meanwhile, the high headline numbers attracted a significant asset swap bid for Triple A paper that hadn't been relevant previously."
The same pattern was seen in the euro market, although the more diversified investor base there ensured the deterioration in new issue terms was more muted. The €3bn 3.125% April 2014 deal for the EIB, sold in January at mid-swaps plus 20bp was tapped twice in the spring at plus 50bp, before a final addition at plus 28bp in May took the total outstanding to an impressive €8.25bn.
KfW attracted strong demand, doubling the size of the existing €3bn 10-year benchmark sold in January at mid-swaps plus 37bp with an additional €3bn at plus 65bp in early April. "The steepening of the yield curve helped issuers restore some of the duration lost elsewhere as continental European insurance companies in particular looked to buy assets offering particular absolute yields to match their liabilities," said Bye.
The result of the steady new issue flow, albeit on increasingly expensive terms, was that by the end of the first quarter both KfW and the EIB were around half way to their annual funding targets. Neither issuer had had any difficulty attracting funding, although there was a common perception that investors were looking for greater diversification.
This partly explains the popularity of SFEF. Having completed €33bn through public debt issuance and €2bn through private placements by the end of March, as well as US$15.5bn of public debt, it had matched the EIB and KfW in terms of its funding requirements. Yet the issuer's popularity failed to provide it with immunity from widening spreads in its outstanding debt. SFEF's €5bn 3% April 2014 deal was priced at mid-swaps plus 37bp, compared to its first five-year trade in January which was priced at mid-swaps plus 15bp.
Half time and all change
By the end of June the pace of activity in the SSA market was diminishing. Many issuers had rushed through substantial parts of their issuance programmes for the year, leaving a fairly open playing field for those borrowers that had bided their time with their funding needs. Cades, the French social security agency, sold a three-year US dollar deal at mid-swaps plus 20bp just a week after paying plus 40bp for a five-year transcation. The KfW five-year US dollar Global sold earlier in the year at the equivalent of 140bp over US Treasuries had seen its spread halved to plus 71bp.
The market had even started to see the resurgence of sub-Libor funding levels in the two-year part of the US dollar curve. The first to break the sub-Libor barrier was the EBRD with the expectation being that the rest of the curve would follow. By the summer KfW had sold €51bn of its expected €75bn needs (68%) and the EIB €62.8bn of its €70bn requirement (about 90%), before this was subsequently raised to €80bn.
After the summer recess it was clear the bulk of the market's funding needs had been completed. Barring any external shock, spreads should tighten in the coming months. The first deals to appear in early September confirmed this: Sweden issued a €3bn two-year benchmark at mid-swaps less 15bp based on a book size approaching €8bn. This was possible because of the performance of its last deal, which had tightened from Libor plus 45bp to around flat in the four months since it was sold, amid rallies in the peripheral bond markets and equity markets.
The US dollar market continued to provide the most favourable terms for new issues, because of the incremental value derived from the euro/ dollar basis swap for European issuers. The EIB exploited this with a US$7bn order book for a three-year Global, enabling it to sell its largest US dollar deal to date, despite the mid-swaps less 10bp pricing being through the secondary levels of some of its existing debt in this part of the curve. Canada also sold its first US dollar Global since 1998 which, although it priced at 15bp through swaps in five-years – looking, on paper, rather miserly – still garnered a book of over US$15bn.
The market was still receptive when the Federal Republic of Germany came with its first offering since 2005. It sold a US$4bn three-year issue at mid-swaps minus 25bp in mid-September, after attracting a book of over US$10bn. "The scarcity of certain sovereign credits has seen these issues tighten from the levels at which they were sold, but other SSAs have found resistance at around the mid-swaps less 10bp level for short-dated US dollar trades. At the longer end of the euro-market, spreads had already started to give up some ground coming into September even though the issuance pipeline was very limited," said Bye.
The US investor base remains crucial, particularly in US dollar deals, albeit less so than earlier in the year. New supply from issuers such as FNMA and FHLMC has declined because of their inability to fund new mortgage purchases at positive rates of carry.
“There does, however, remain a significant buy and hold bid even as issuance levels move into negative territory in terms of swaps," said Dan Shane, head of SSA syndicate at Morgan Stanley.
Some of the largest SSA issuers have now completed sizeable amounts of their 2009 programmes, and the availability of liquid benchmark offerings is likely to be limited. "The real question is what sort of equilibrium will be established when, as expected, the intervention of central banks around the world comes to an end next year," Shane said.