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Tuesday, 24 October 2017

Liquidity returns

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Agency issuers have been adhering to the principle that one should make hay while the sun shines, thereby evading the uncertainties around their sovereign patrons and reaping a rich harvest in the first few months of this year. David Wigan reports.

To view the digital version of this report, please click here.

The year started with an explosion of sales of agency debt in January and February. This was particularly true in Europe, after a rise in yields and risk aversion fuelled investor demand for highly-rated securities.  Despite economic tribulations in Greece, Ireland and Portugal, European agencies sold €154bn of debt this year up to the third week of April, according to data provider Dealogic. In 2010 they sold €272bn.

Supply dynamics in the agency space traditionally favour early movers, and this year was no different. However, issuance over the first weeks of 2011 exceeded the most bullish of expectations. Originators expressed surprise at the market’s ability to absorb political shocks. There was even talk in frothier corners of a return to the heady days before the demise of Lehman.

“The market has had a phenomenal performance, in particular in terms of issuance ability,” said Carl Norrey, head of EMEA rates securities at JP Morgan. “Reaction has been very positive and it’s been the best beginning of the year we could have expected.”

The rude health of the market comes despite a government debt crisis over the past year. Ireland, Portugal and Greece have been virtually shut out of the capital markets and were obliged to apply for funding to the European Financial Stability Facility (EFSF).

One explanation for the rise in early issuance, analysts say, is that some agencies are under pressure to fill the gap left by reduced lending in the commercial sector.  Spain’s Instituto de Credito Oficial, for example, had by the third week of April sold €13.6bn, almost matching its €14.5bn of issuance for the whole of 2010 and accounting for more than 65% of its planned issuance this year.

ICO has prospered with a strategy of waiting for a period of political and economic calm and then acting decisively. “When we see a period of stability we must be nimble,” said Antonio Cordero, ICO’s deputy director of financial markets. “There is a sense that anything might happen, and there are a lot of headlines, so the key is to take advantage when the environment is positive.”

Pricing has been a key driver of investor demand, with the substantial widening in Spanish sovereign yields running alongside wider spreads to the benchmark.

A benchmark Spanish 10-year sovereign bond was sold early this year at a yield of swaps plus 225bp. Last year the same bond printed at swaps plus 56bp. At the same time ICO is offering 70bp over the sovereign in longer maturities, compared with 20-30bp a year ago.

Bargain basement

“One of the reasons we have seen such a great run over the first part of the year is that prices are at entirely different levels from where they were 12 months ago, whilst fundamentals have also moved on” said Lee Cumbes, head of public sector origination at Barclays Capital in London. “The market sees an attractive opportunity because in the end, you can buy paper with a Spanish guarantee and coupon levels of close to 6% at 10 years.”

More realistic pricing has enabled agencies to push longer maturities. Spain’s ICO and new issuer FADE successfully printed 10-year deals, an unusual phenomenon in 2010.

Still, the government debt crisis is having an impact in specific areas of the market, and in particular the investor base. 

“We have seen a pull back in terms of the size of orders from Asian accounts and also some scepticism over Europe’s fate from US investors, which means that we are relying more heavily on European investors,” said ICOs Cordero.  Asian and US participation has fallen from around 25% of the total to around 10% in recent deals, he said. Despite the difficulties in non-euro currencies, the agency has found demand in small ticket sizes, for example issuing in the Uridashi format in a ¥15.57bn (€130m) 4-year deal.

While Spanish issuers have been forced to cut their coats according to the macro-economic cloth, agencies less intimate with the sovereign peripheral crisis have faced no such restrictions. Such issuers have often seemed to benefit from a flight to quality, with bank treasury accounts reported to be among the most enthusiastic supporters as they seek to reinforce their capital bases.

Germany’s KfW sold some €36bn of bonds in the year to the third week of April. That accounted for nearly 50% of its annual funding, which will be around €75bn for the full year, similar to 2010.

According to Horst Seissinger, head of capital markets at KfW, the agency has seen high investor demand, but has been mindful of the wider environment. It has adopted shorter lead and execution timetables, and more accommodative price talk.

“It’s no longer possible just to refer to the secondary market for pricing,” Seissinger said. “We need to pay a fair price and not stretch the order book. That means adjusting the yield so that we get oversubscription, and ensure there is room for some outperformance (once the bond starts trading).”

In part because of a less favourable climate in emerging markets, the agency has cut its commitment to foreign currency issuance. It has issued in 10 currencies so far this year, compared with 20 currencies in the same period last year. Some 44% of issuance was in euros, with 36% in US dollars. There have also been deals in sterling, South African rand and Brazilian reais.

An evolving opportunity for agencies is the so-called Dim Sum bond market, the renminbi-denominated format operating out of Hong Kong. The market has grown as the Chinese government has progressively loosened restrictions on issuance, allowing supranational issuers such as the World Bank to successfully institute Chinese currency programmes.

According to KfW’s Seissinger, the agency was considering entering the renminbi market. The agency’s biggest caveat is that in any foreign currency market it always needs the option to swap back into the US dollar or euro across maturities.

“We try to become active in these markets but where the cross currency market is not liquid there are a lot of challenges,” he said.

The land of opportunity

One jurisdiction of increasing interest to Europe-based issuers is the US. The winding down of Fannie Mae and Freddie Mac seems almost certain after the idea was floated in a Treasury white paper in February. With their issuance waning – and increasingly focused on the short end – a vacuum has emerged, presenting an opportunity to European issuers.

Many have wasted little time in preparing to the tap the dollar investor base. Dutch public sector agency Bank Nederlandse Gemeenten and Norway’s Kommunalbanken have set up private placement programmes under SEC Rule 144A, and  France’s Caisse d’Amortissement de la Dette Sociale (Cades) launched a 144A programme in March with a US$2.5bn five-year deal.

“Fannie and Freddie, alongside Federal Home Loan Bank and Federal Farm Credit, are still significant issuers, for example Federal Home Loan issued US$530bn of term debt last year,” said Jeffrey Diehl, global head of public sector capital markets at HSBC.  “But Fannie and Freddie are shrinking and Federal Home Loan Bank issuance has come down from its peak, so the reduced issuance is driving a lot of European agencies into the US market.”

Another key driver of the move into dollar issuance, Diehl said, is the positive basis swap, whereby European issuers can swap out of dollar funding into relatively cheap euro funding.  Last year, European issuers could swap out of dollar Libor plus 10bp into Euribor minus 30, though the trade has moved slightly against the issuer in recent weeks to around Euribor minus 10bp.

“Dollar issuance has been fantastic though the currency basis is starting to collapse,” said JP Morgan’s Norrey. “It is not quite the attraction it was.”

While the agency market got off to a flying start in 2011, some clouds have appeared in recent weeks, with the secondary markets hit by spread widening amid talk of a Greek debt restructuring. Still, issuers outside those territories talk increasingly of a decoupling between the troubled peripherals and the rest.

“There has been some retracement but even if we see restructuring in Greece, that won’t necessarily have an impact on issuance or performance in Spain,” said Juan Garnica, head of Public Sector DCM at BBVA.  “The market has become much more sophisticated in differentiating between Spain and other peripherals.”

Another focus in the secondary market is liquidity. Bids are much more prevalent than offers, reflecting the buy and hold preference of the investor base.

“We are trying to facilitate liquidity of our transactions in the secondary market,” said ICO’s Cordero. “It’s the arranging banks duty to provide liquidity, and as part of choosing lead managers for our transactions we are monitoring flows and pushing the banks to do a good job.”

The top five managers in the euro-denominated agency space so far this year are Deutsche Bank, HSBC, BBVA, BNP Paribas and Barclays, according to Thomson Reuters data.

With agencies pushing for better liquidity, the quid pro quo demanded from the bank side is action on the issue of collateral.  Sovereigns and agencies swapping from fixed to floating rates and vice versa are traditionally not required to post margin against those swap positions, but banks have launched a campaign to try to persuade them to change policy and sign up to so-called two –way credit support annexes.

“This is the biggest single issue that affects all of us,” said one banker close to the situation. “At the moment not many at all are signing up to two-way CSAs – they are all aware of the issues and some are looking at it, but they are putting their heads in the sand.”

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