Dollar demand deepens for IFC

IFR IMF Special Report 2011
10 min read

With appetite for Washington DC-based supranational borrowers supported by the European debt crisis, the IFC secured a quarter of its US$10bn funding requirement for fiscal 2012 in just one month. Despite this early success, it expects to issue two dollar global benchmarks in the autumn and spring and to pick up arbitrage funding opportunities as they become available.

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John Borthwick, IFC deputy treasurer and head of funding at the IFC, says that after four years of programme increases, the issuer now does the majority of its funding in the handful of markets able to provide cost-efficient volume and duration.

““The funding program has grown from USD2bn to USD10bn and we see it remaining at around that level over the next few years. As a dollar-based institution swapping from Euros doesn’t work for us, so it’s fallen to the dollar global and Kangaroo market to do most of the work,” he says.

During the last fiscal year, US dollar investors supplied some 59% of the IFC’s funding requirement, with Australian dollar buyers the second most active investor base providing 20%, according to data supplied by the IFC. The borrowers’ fiscal year runs from July 1 to June 30.

Overall, the borrower tapped 13 currency markets in the full year of 2011 according to IFC data, with notable supply in local currency markets with attractive cross currency basis swap dynamics for dollar funders such as Turkish lira (5.1% of total issuance), South African rand (4.6%), and Brazilian Real (4.2%). Further diversification came via sterling, Mexican peso, New Zealand dollar, Russian rouble, Chinese renminbi, South Korean won and Japanese yen. Euro issuance accounted for just 0.2% of the borrowers annual haul.

Increased issuance, and therefore greater liquidity, brings with it significant strategic advantages among domestic US institutions, which have historically viewed the IFC as relatively illiquid compared with the International Bank for Reconstruction and Development and the European Investment Bank.

Borthwick notes that the borrower’s credit quality and the eligibility of its debt as a liquidity instrument for regulatory capital purposes is driving increased traction with a variety of US accounts at a time when they are seeking alternatives to US agencies.

“The US is a new market that has opened up for us. The fact that we are a high-grade US-based supranational issuer with a global shareholder base has allowed us to develop a niche based on our strong credit, and we continue recruit new investors among cash rich corporates and bank treasuries,” he explains.

US investors have responded well to the addition of a second dollar global to the borrower’s benchmark calendar, dealers say. Before the 2011 fiscal year, the IFC would typically bring a single benchmark in the US$1bn–$2bn range. Last fiscal year it printed two, including a US$2bn seven-year in November 2010 and a US$2bn five-year in April 2011. Priced at mid-swaps minus 2bp, the seven-year was the first supranational five-year benchmark to achieve sub-Libor funding since the third quarter of 2008.

Raymond Seager, director and co-head of public sector debt capital markets at Bank of America Merrill Lynch in London says that strong demand for the credit has allowed the IFC to maintain price tension relative to its peers amid growing supply. “In the past when the IFC had a smaller funding programme, they could only do one USD1bn benchmark a year and a limited variety of other transactions. Now with the increased needs they’ve been able to target a wider variety currencies like AUD, as well as retail and structured trades that has not only achieved about a good cost of funds, but has actually brought new investors into their benchmark programme. The US is a good example of this,” he says.

Propelled by a combination of attractive cross currency basis swap pricing and investor preference for US-based supranational credits over their European peers, Australian dollar accounts have become a key strategic investor base for most Washington supranationals. With one of its first major transactions of FY2012, the IFC distinguished itself as a leading credit in the Kangaroo sector with a A$1.5bn two-tranche five-year deal, the largest by any SSA borrower in the sector so far this year.

“When the European and Asian central banks join with the Australian banks and funds, the stars align and the Aussie dollar market is capable of providing a significant quantum of debt”

Borthwick says that the borrower had initially intended to launch a transaction in the A$500m–A$700m range, but took advantage of strong investor demand among both domestic and international buyers to print the record-setting deal. “When the European and Asian central banks join with the Australian banks and funds, the stars align and the Aussie dollar market is capable of providing a significant quantum of debt,” he says.

He adds that the IFC has been able to achieve very similar after-swap funding costs in Australian dollar as it does issuing directly in US dollar, although basis swap markets are volatile and not always supportive. “We are finding that our costs are comparable between the US dollar and Australian dollar markets similar between the markets, although the basis swap arbitrage has narrowed since we launched the five-year,” he adds.

Notwithstanding the strength of the IFC’s latest launch, an Australian Prudential Regulatory Authority ruling regarding eligibility criteria for Level I Assets under Basel III earlier this year could limit Australian deposit taking institutions’ appetite for supranational bonds going forward.

At the end of February, APRA departed from the Basel Committee’s recommendations on global liquidity standards by ruling that Australian dollar bonds issued by supranational borrowers will not qualify as Level I liquid assets. The APRA ruling, which also excluded covered bonds from Level 1 eligibility represents a significant tightening of liquidity standards versus its global peers and the Basel Committee itself, which designates debt issued by “multi-lateral development banks” as a Level I asset.

However, BofA Merrill’s Seager points out that with increased participation from European and Asian central banks, the IFC’s Australian dollar constituency extends beyond APRA’s regulatory reach. Furthermore, with many market participants suggesting that the Australian dollar is fast becoming a secondary reserve currency, this investor base appears to be growing.

“With increased participation from Japanese retail investors and central bank reserve managers, the IFC’s Australian dollar investor universe extends beyond the domestic institutions. These investors’ appetite for high quality alternatives to the US dollar will continue to provide compelling funding opportunities for the IFC and other Washington supras,” he notes.

The borrower further demonstrated its willingness to service the flight-to-quality among international investors with its debut Norwegian krone transaction, a NKr1bn 3.25% five-year timed to exploit spiking aversion to European credit risk at the end of July.

Borthwick says that the combination of global investor appetite for diversification away from European agencies and an attractive basis swap window created ideal issuance conditions. The deal, which beat the borrowers’ initial volume expectations, was distributed among global retail investors, Nordic institutions and global central banks, adds Borthwick.

According to the IFC’s August 2011 investor roadshow, the borrower expects that structured note and private placement issuance could contribute between 30%–45% of its fiscal 2012 funding requirement. Although a US$350m callable placed into the US in July shows that the borrower remains a favoured issuer among structured note investors, the general pull-back from complex derivatives products among both institutional and retail investors reinforces the borrowers’ strategic tilt toward benchmark issuance.

“We’ll continue to borrow in Japan and do small structured notes, but much of the remainder of our fiscal 2012 programme will come from two dollar globals in the autumn and spring of 2013,” Borthwick says.

With the erosion of the US Government Sponsored Entity issuer bloc, the Washington-based supranationals in general, and the IFC in particular has an unexpected opportunity to raise its profile in among US dollar investors. The importance of raising these buyers’ awareness and keeping it at elevated levels is clearly a matter of strategic priority for Borthwick’s team which will routinely post slightly wider levels in the US versus other currency markets to maintain traction with its core funding base.

“We are a dollar based institution. We have worked hard to make sure we have a good reception, and ultimately we need to be able to fall back on our global dollar bonds. We will continue to supply dollar globals even if we have cheaper opportunities available elsewhere. Its never been a case of cost being the ultimate factor. The dollar global market is one of the few venues where you can access volume, without it we would be very hard pressed to raise the funds that we need to drive our business,” he says.

BofA Merrill’s Seagar concurs. “With many frequent borrowers caught by the contagion of the European debt crisis, dollar investors have welcomed the IFC’s increased issuance volumes. Given its ownership structure and credit quality, the borrower has easily grown the funding programme and could comfortably do so further should the need arise,” he concludes.

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