Adapt or die
The SSA market has successfully responded to the changed landscape since the introduction of the sovereign guaranteed bank sector last autumn. Many issuers, mindful of potential market disruption, are already at advanced stages of their borrowing programmes for this year, just as signs emerge that credit market conditions are beginning to improve. Mike Winfield reports.
Europe's largest issuers have had to adapt to dramatically changing circumstances in recent months. There has been a marked increase in both the number of issuers and the overall growth in borrowing volume since last year. The pricing they have been able to offer has undergone an almost overnight transformation, due to European sovereigns being forced to guarantee the debt required by their beleaguered banks, struggling against mounting credit losses.
Many issuers have responded by seizing all available opportunities with both hands. It has allowed some to complete impressive amounts of borrowing in the first three months of 2009. However, as spring got underway there were nascent signs that credit market conditions were beginning to improve. "Within little more than three weeks there was a sea change in sentiment as sovereign spread tightening allayed fears of a euro break-up, and healthy cash flows and improved corporate earnings led first to better secondary performance and then to an improving new issue market, "said Sean Taor, head of SSA syndicate at Barclays Capital.
In previous years much SSA supply has been focused in the early months of the year. This has regularly led to a disproportionate number of redemptions in the first few months of the year, in turn encouraging issuers to front load their offerings. Last year saw a particularly large deluge of short-dated US dollar supply, although the consequences of that won't be seen until next year or 2011, when the three-year deals begin to mature. "In order to avoid the rush to refinance shorter-dated deals maturing in the next few years, issuers really need to have the ability to raise debt of five or more years," Taor said.
True to form, the largest European issuers were busy in the first quarter. KfW is almost half way through its €75bn programme, while the EIB just over half way to its €70bn target by mid-April.
Most of the major issuers rely upon a combination of funding in US dollars, euros, sterling and non-core issuance – including Australian, Canadian and New Zealand dollars – as well as other Scandinavian currencies and those which are usually available only on a more opportunistic basis. Historically, non-core issuance and the sterling market may have made up around 15% each of some borrowers’ requirements, creating a fairly diverse mix of deals to reach their target amounts. This year has been different, with minimal contributions from the smaller currency markets resulting in a focus on the main sources of funding: US dollars and euros. Typically these markets have offered three main maturity segments which have offered liability duration to match underlying assets (the short-end, five-years and 10-years).
In 2008 and 2009 some expected that the prominence of the sovereign-guaranteed supply in the sub-five year sector would drive SSA supply towards the longer-dated part of the curve. Some argued this would enable issuers to restore the loss of duration seen in 2008 and avoid the heightened competition for funds following the creation of the new bank asset class. KfW was the first to test sentiment with a €3bn 10-year offering in January at a level of mid-swaps plus 37bp. Despite attracting a final book size of over €5bn (which surprised some market participants at the time), this remained the only longer-dated supply until the EIB priced a €2bn EARN deal at mid-swaps plus 55bp in February, the wider end of the initial guidance set at plus 45bp-55bp. This seemed to suggest that, far from offering an alternative to the short-dated supply, appetite for longer dated paper was actually contracting.
This forced the largest SSA issuers to go into head-on competition to raise two and three-year debt – just as they had been in 2008. At one point a London-based syndicate official said only the best quality issuers could issue at all in the challenging three-year part of the US dollar curve.
The declining appeal of smaller currencies has seen euro-denominated supply become significantly more important as a funding tool – despite the sustained elevation of the euro/US dollar basis swap level. At different times of the year, and depending on maturity, the basis swap has reduced the cost of Euribor funding by over 50bp, with the threes/sixes basis worth up to another 8bp in the five-year part of the curve.
The reduction of the Euribor cost of funding through swapping US dollar proceeds has seen a convergence of the relative costs of the two sectors. When KfW raised US$4bn at an eye-catching mid-swaps plus 95bp in early March it benefited from the euro/US dollar basis swap, which was worth around mid-50s, in addition to about 7bp through the threes/sixes basis swap. This enabled it to achieve a slightly better all-in cost of funding than was available through issuance in euro format when it sold a €5bn February 2014 deal at Euribor plus 47bp the previous month. The euro market has continued to provide the better options, reflected in its rise to prominence this year compared with 2008, at a time when overall euro SSA volume is 65% higher – including both syndicated and auction supply. "This disguises the important rise in supranational issuance (attributable to the EIB), and a similar rise in agency supply, as well as around a 40% increase in sovereign and regional supply," said Zeina Biginer, head of DCM at SG CIB.
By late spring there were signs that market conditions may have been improving – albeit from the wider pricing base the SSA sector had reached. The five-year KfW US dollar Global deal, sold at mid-swaps plus 95bp, had tightened in the secondary market by 25bp, and was followed by new five-year appearances from the IADB, the IFC and Export Development Canada, each at progressively tighter spread levels, in mid-April. KfW's 10-year euro-benchmark trade, sold at the beginning of the year, was doubled to €6bn when tapped the same month, making it the issuer's largest outstanding euro-denominated deal. The Hellenic Republic went one step further, adding a €7bn tap to its original €5.5bn five-year government bond at mid-swaps plus 225bp, or 35bp tighter than the original offering.
The prospects for the rest of the year are generally perceived as positive, although the market will remain awash with government-backed bank supply as well as the increased financing needs of the sovereigns themselves. But there is much talk about a new kid on the SSA block which is challenging the largest existing issuers for debt: Societe de Financement de l'Economie Francaise.
Its mission is to inject the proceeds into the French banking system to allow for the normal functioning of the economy, with a focus on helping corporates, households and local authorities. In addition, the French State Shareholding Corporation can make up to €40bn available to strengthen the capital ratios of credit institutions to restore confidence in their financial strength. The government is also committed to injecting capital directly into credit institutions if necessary. It's first public deal last last year was a €5bn 3.5% November 2011 issue which was priced at the mid-swaps plus 5bp, after attracting a final book size of over €12bn.
Since then it has raised benchmark debt in both euros and US dollars with two, three and five-year maturities, most of which has priced towards the tighter end of the guidance set and all of which has been oversubscribed. Although to achieve this, new issue spreads have been under some pressure relative to mid-swaps in common with other SSA issuers: the last five-year SFEF trade was priced at 37bp over mid-swaps at the beginning of April. By contrast, the issuer first appeared in the US dollar market with a US$6bn three-year deal at 40bp over swaps, before raising US$5.5bn in two-years at plus 45bp, then US$4bn threes at plus 50bp.
SFEF was born from France's decision to create a specific body to support its banking industry. Its expected annual financing needs will place it in direct competition with the largest issuers historically, KfW and the EIB.
SFEF had been able to raise over €54bn equivalent by late April, made up of €33bn through public debt issuance and €2bn through private placements, as well as US$22.5bn of public debt and a US$3bn private placement. The apperance of this new Triple A rated issuer has combined with the sovereign guaranteed individual bank supply to create a market in which competition for funds has become increasingly intense – exacerbated by ongoing risk aversion focusing supply on the shorter part of the credit curve. SFEF itself only currently issues debt of up to five-year's maximum maturity, putting it in competition with most other guaranteed supply.