While the effects of the credit crunch have mainly impacted the lower tiers of the credit pyramid, the rating differentiation at the apex has also exposed pricing differences between SSA issuers of the same credit rating. Where ratings differ the gulf is even more extreme, reflecting the price investors will pay for peace of mind. Michael Winfield reports.
Investors are behind the popularity of the front-end for debt issuance since the advent of the credit crunch: it is the natural preserve of the central banks which now make up much of the SSA investor base. Accordingly fund raising has focused much more on the short end than in previous years, accompanied by an almost total absence of issuance in the 10-year part of the curve.
Consequently, the maturity profile of most issuers' outstanding debt has shortened, and their overall liability duration has fallen. "While the factors behind this remain in place, this situation is expected to continue for the foreseeable future, namely the steepness of the US yield curve and the inflated level of interest rate swap spreads at the short end which itself is a product of the banking crisis," said Myles Clarke, director of the frequent borrower group at RBS.
Just over a year ago the SSA market was reopened by the EIB with a US$3bn three-year trade at mid-swaps less 20bp, 1bp tighter than a similar transaction it completed well before the onset of the credit crunch. By comparison, it completed a similar trade this year at roughly the same time at a spread of mid-swaps less 35bp, raising US$4bn in the process. This dramatic change can be attributed to two complimentary factors: the deterioration in the credit of the banking sector (represented by the Libor curve) and the premium investors will pay for the credit quality of a borrowing institution such as the Triple A rated EIB.
Similarly, KfW the largest of the SSA borrowers, has also seen a contraction in the sub-Libor margins at which it has been able to fund its expected €75bn annual borrowing requirement for 2008. Recently it completed a three-year global transaction at swaps less 28bp, which was around 10bp tighter than it might have achieved before the credit crunch. Both issuers have been overall beneficiaries of the flight to quality trade that has occurred, although one banker suggested there was a differentiation between supranational and agencies: the EIB is less comparable to other issuers, affording it a greater rarity value than KfW, which shares the guarantee of Germany with a number of other issuers.
Other less frequent Triple A issuers such as Export Development Canada have also been able to join the party, most recently completing funding at swaps less 35bp in three-years – also around 15bp tighter than last year's trade at less 20.5bp. The list goes on of borrowers that have achieved previously unthinkable sub-Libor funding, as investors have chosen to focus on the short end of both the euro and US dollar markets.
Basis helps sovereigns
Many European issuers have been able to optimise their funding cost by raising US dollar funds and swapping the proceeds back into euros, because of the distortion to the basis swap market created in the wake of the credit crunch. This recently enabled the Triple A rated European Bank for Reconstruction and Development (EBRD) to issue two-year debt at US dollar Libor less 35bp, before gaining as much as another 17bp (before costs) by swapping the proceeds into euros. In fact the overall cost of funding was so attractive, the EBRD bought back some of its other outstanding debt to increase the size of this issue to US$450m.
This incremental benefit for European-based issuers has not been lost on some of Europe's sovereign borrowers, with the Kingdoms of Belgium and Spain, as well as the Hellenic Republic, issuing in US dollars for the first time in many years to capture the full value of the basis swap. "Although such is the disenchantment with the euro market overall – as the ECB maintains its hawkish monetary posture at a time of rising inflation – that investors have between the beginning of 2007 and this September, failed to return €340bn to the fixed income market as a whole, this being the difference between redemptions compared to new issue volumes," said Zeina Bignier, head of SSA debt origination at Societe Generale CIB.
One consequence has been the relative lack of 10-year debt raised in 2008, with the EIB having only gone as far as the seven-year point with an EARN transaction. In fact, of the larger 10-year benchmarks issued this year, most have been for KfW: it has twice tapped the US dollar market and once the euro-sector.
The most recent of these deals was done at the beginning of the summer at mid-swaps less 12bp and was widely thought to have mopped up most the demand in this part of the curve with an eventual order book of US$3.3bn for its US$3bn Global offering. The pricing of this deal exemplified the extent of the inversion of the credit curve, as the 25bp sub-Libor gradient between its two and 10-year deals shows the extent to which investors are generally shunning longer dated paper. "For much of last year the credit curve was largely homogenous, offering issuers the benefit of being able to fund longer without any significant cost disadvantage as investors looked to the longer end of the curve in pursuit of yield," said Dan Shane, head of SSA syndicate at Morgan Stanley.
Not a level playing field
While the options available to the 0% risk-weighted borrowers have made them net beneficiaries of the credit crunch, issuers with split credit ratings have been the losers, as some investors have spurned their debt offerings. Eksportfinans, rated Aaa/AA+/AAA, made its first capital market foray of 2008 in April with a €1.25bn three-year trade at mid-swaps plus 13bp, followed by a €1bn five-year deal at swaps plus 17bp in June. By comparison, at the end of 2007 it cancelled a two-year transaction which was being marketed at swaps less 3bp–4bp, before failing to gather sufficient traction in a market characterised by excessive underlying volatility.
The scuppered sale also followed an announcement by the borrower that it had made losses as a result of a mark-to-market, relating to securities it held for "liquidity purposes" – which may also have been of significance to potential investors, particularly as the holdings were of structured bonds. Moody's had already adjusted Eksportfinans' Aaa rating outlook from stable to negative, but investors failed in some cases to be reassured by comments from the export credit agency relating to the investment portfolio.
Despite the risk aversion shown to anything other than Triple A rated agencies, supranational issuers and European sovereigns, those borrowers outside the top tier club have achieved their funding elsewhere. Institutional or private wealth networks in the US, spread across different asset classes, have taken up much of the slack for Eksportfinans. Swedish Export Credit, rated Aa1/AA+, has also not appeared in benchmark format so far this year, and has looked to the Uridashi market and structured notes targeted at US investors as an alternative source of funding.
One consequence of this approach may be a reduction in duration and a consequent dependence on refinancing in the future. In addition, the absence of a borrower from the market for a sustained period of time may, some bankers think, add to the ultimate cost of returning to the public markets – especially as some top tier issuers are currently seeing an expansion of their borrowing programmes.
For the Triple A rated Nordic Investment Bank (NIB), there were two priorities when it priced a US$500m five-year deal in September: "To extend investor reach by emphasising retail participation"; and "the need to fund as long as possible to extend the current average maturity of our outstanding liabilities from the current 3.7 years to nearer the 5.0 level of 2007," said Kari Kukka, head of funding and investor relations at NIB.
It has also been notable that some of the non-core bond markets have become less significant for most SSA borrowers during 2008. The Canadian dollar sector is almost non-existent for overseas issuers, mainly because of the low absolute level of yields relative to those in the US. The negative effects of the appreciation of the Canadian dollar have not helped: just like the Australian dollar, it is inextricably linked to commodity prices.
These factors have also contributed to the concentration on issuance in the core bond markets, with the US dollar market likely to remain central to the SSA borrowers with financing still to complete this year. Ultimately, "as long as there remain fundamental problems with the financial system and perhaps particularly as we approach the calendar year end, short dated US dollar swap spreads are likely to remain elevated despite the anticipated relatively high volume of new issuance which should in theory act as a counterbalance to this," Clarke said.