GEs Double A surprise

Bond markets have experienced an issuance bonanza this year, with both the size and frequency of deals in the ascendancy. Triple A activity has traditionally been frenetic in the first quarter of the year, with much of the issuance from the major agencies coming near the start of the year. There has, therefore, been a lot of Triple A paper knocking about in the first months of 2009. But in certain fundamental respects, the Triple A sector in 2009 has started to look very different from previous years. In the SSA market there has been a move away from diversifying issuance into a range of smaller currencies and a focus on core currencies, with the euro, in particular, coming to prominence. Simultaneously, there has been evidence of an increasing appetite for shorter dated paper, in response to a general feeling of uncertainty about the future which has affected issuers and investors alike. This has been a real challenge for some issuers, who have found themselves unable to distinguish themselves from sovereigns and top quality corporates by concentrating on a different point of the curve. The general focus on the short end has seen a greater level of scrutiny even within the Triple A universe, and those found to be of relatively inferior quality have found themselves to some extent squeezed out. SSAs, in particular, have had to contend with the much discussed emergence of government guaranteed paper – no small encroachment on their traditional investor territory – adding to the general feeling of claustrophobia. At the other end of the Triple A spectrum is the ever-newsworthy world of structured finance, the corner of the financial markets that divides opinion more than any other. As far as ratings are concerned, the key debates have been whether securitisations should even be dignified with the prestige of a Triple A rating. In the blue corner are those that feel they sully the good name of those corporates, sovereigns and others that “deserve” the title; in the red, those (among them many investors) who counter that taking away this title would effectively shut them out of such investments. Many possible solutions have been floated, including a new rating scale for securitisations, a more rigorous rating criteria for securitisations or additional suffixes for structured finance ratings to denote rating volatility and sensitivity to changes in model assumptions. The debate rages on, but it seems a tightening of the criteria by which structured finance transactions are rated is the only likely change. This is in part due to an emerging recognition that the negative sentiment surrounding securitisations may have exaggerated quite significantly how hopeless the prospects for these instruments were. The expected number of downgrades and defaults have not materialised and Triple A structured finance instruments have in some cases actually held up comparatively well. The picture is muddied by the discrepancies in the behaviour of different types of transaction: UK prime RMBS have retained their ratings very well compared to US ABS CDOs, which have seen downgrades and defaults aplenty. One thing is clear: if the goal is to create a gold standard, so that the credit rating of all securities rated Triple A are comparable, implying an equal probability of default, then there is a long way still to go.

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). Limited options 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-denom

Forget Triple A: as long ago as September 2007, UBS's head of CDO research, Douglas Lucas predicted that even the super senior debt would see not just rating migration but principal loss. Of the 122 ABS CDOs backed by US sub-prime mortgages that he studied, 10% of bonds suffered a collateral loss of 37% leading to an expected tranche loss of 1%. At junior Triple A level, collateral losses of 24% would affect 30% of bonds, leading to an expected tranche loss of 20%. At that time Lucas said this constituted the biggest ever failure of credit risk management or of ratings. David Preston, a CDO analyst at Wachovia Capital Markets, said that to date 328 of the 730 ABS CDOs issued between 2002 and 2007 in the US are currently in an event of default. They had a nominal value at issuance of US$325bn, representing a little over half the total US$642bn of ABS CDOs that were issued. The later issues are in much worse shape. A staggering 72% of deals issued in the second half of 2006 are now in EoD, while as many as 78% of deals issued in 2007 are in EoD. Yet as terrible as that is, the overall global picture for structured finance is actually much, much brighter. Over the last 30 years, 19% of global structured securities that were originally rated Triple A have been downgraded. Better still, only 0.7% have defaulted, according to S&P. In the last year, 24% of global structured finance S&P rated Triple As have been downgraded and just 0.2% have defaulted. This illustrates a key point that the market currently chooses not to recognise: although the Triple A downgrade rate has been relatively high, particularly for US sub-prime ABS CDOs – the global default rate for Triple A structured finance transactions is still very low –no different, in fact, from other asset classes. Though Triple As cannot ever be bullet-proof, both their downgrade rates and default rates are significantly lower than for junior rated structured finance debt. Despite the sub-prime debacle, these top-rated instruments have done what they're supposed to do – deliver a genuinely lower risk credit exposure to investors. No credit rating can assess market valuation or investment suitability. According to Martin Winn an S&P spokesperson, Triple A is "not a guarantee that the market value of a security will never fall." The trouble is that market value has, and continues to play, a very negative role in the psychology and perception of all structured finance debt, irrespective of rating. The market value and related liquidity of many Triple A instruments has fallen heavily, "even when, in our opinion, their creditworthiness has not been significantly impaired,” Winn added. Take the UK prime RMBS market. HBOS' Permanent Triple As, like all UK master trusts, can withstand as much as 16 times loss coverage of the early 1990s UK recession. That is about as bullet-proof as Triple A ratings can get. Yet, with the meltdown of structured investment vehicles and other key constituents of the ABS investor base, the spread pick up in the secondary market is around 600bp to 700bp above three-month Libor – compared to around 10bp at launch. It is mistakenly tarred by the same brush as genuinely poor credit securitisations, such as US ABS CDOs. There is a perception that all structured finance debt is basically toxic, and a Triple A rating has been essentially meaningless in combating that perception. Because both UK prime RMBS and US ABS CDOs were originally rated Triple A, it is perhaps understandable why these perceptions arose. But the fact that not all Triple A securitisations are created equal explains the staggering level of ignorance that, even today, is seen at the highest level of governance. This was exemplified by the UK government's decision to provide a credit indemnity on Triple A prime UK RMBS – despite the fact that there is no specialist ABS investor who wants it. Investors are happy with Triple A UK prime RMBS credit. Bank of America-Merrill Lynch research hit on this

ICO is a 100% state-owned institution founded in 1971, supervised by the Spanish central bank and rated Aaa/AA+/AAA in line with its guarantor, the Kingdom of Spain. Its role is to "support and foster any economic activities which contribute to the growth and the improved distribution of the national wealth. [In particular activities] which, on account of their social, cultural, innovative or ecological significance, merit priority attention." In order to provide direct financing to fulfil its objectives, ICO borrows against its €43.9bn loan portfolio to mainly SMEs and domestic loan recipients (which made up 94% of the total as of December 31 2008). ICO has seen steadily increasing activity recently, with a 45% rise in year on year interest revenue between 2004 and 2008. International funding grew by €16.4bn in 2004, rising to €39.4bn by 2008. In terms of medium and long-term financing, the overall amount to be funded has risen from just over €3bn in 2004 to €14.6bn last year, with a projected requirement of €20bn for 2009. This was mainly financed by debt issuance in US dollars and euros in 2008 (at 44.5% and 36% respectively). Sterling was the third most important element at 10.7%, while other currencies accounted for 8.8%. ICO draws on a broad investor base which sees Asia with a 20% role, the Americas 14%, the Middle East 10% and Australia 1%. Europe provides the most significant number of investors at 55%. Finally, according to last year's data, central banks, asset managers and banks are the most important investor types, with 49%, 27% and 18% respectively. Insurance companies, pension funds and retail make up the balance. This year, ICO is expecting to issue between three and four benchmarks in both euros and US dollars, as well as complimentary issuance in other currencies to reach its target level of funding. Market developments, however, are likely to impact on some of the patterns seen last year both in terms of the relative importance of different parts of ICO's investor base, and in terms of the probable currency composition by the end of 2009. In terms of investors, the repricing of the SSA sector as a whole has seen a much greater reliance on the domestic account base than has historically been the case for the SSA market in general. ICO raised €1.75bn with a 3.375% December 2011 trade late last year in an exercise aimed at prefunding some of this year's needs, at what is now a very attractive level of mid-swaps plus 28bp. "The SSA sector has been re-priced since the advent of sovereign-guaranteed supply, [making] our debt more attractive to domestic asset managers and insurance companies,” said Antonio Cordero, ICO's head of funding. “The placement in Spain has consequently increased." On this occasion, 39% was placed domestically, compared with the 11% for ICO's last two euro-denominated deals. Additionally, the first quarter of 2009 has seen the euro-market providing the better financing opportunities enabling ICO to price a €1bn five-year deal in early January at mid-swaps plus 60bp, as well as a €2bn three-year at swaps plus 75bp. ICO also undertook a Japanese investor roadshow ahead of a ¥50bn five-year dual-tranche Samurai deal, priced in April, after it registered a ¥300bn Samurai programme in January. This was larger than the expected ¥30bn size and resulted in an oversubscribed transaction that was capped at ¥50bn at the issuer’s request for liquidity reasons. The domestic format of the deal attracted rare regional interest which was understood to have accounted for about one-third of the demand for the floater. Central financial institutions were also strong buyers and were rumoured to have taken a similar share in the FRN and close to half of the fixed portion. ICO is now understood to be looking to launch some yen private placements on the back of reverse enquiries it received during the marketing period. It is also mulling a return to the Samurai market in the second half of the year if there is s

Cades was founded in 1996 as an integral part of the French central government. Its remit was to amortise social debt until its objective was achieved. According to the original plan the issuer should have ceased to exist in January this year, although additional transfers have extended the operational life of Cades. The latest additional debt transfer is likely to see Cades in operation until 2021, based on current projections. In order to finance its operations Cades has raised both conventional and index-linked debt. It operates in the euro and US dollar markets, as well as issueing in other currencies such as sterling and both Australian and Canadian dollars. "Cades, as one of the larger SSA issuers and as the manager of French public social debt which is part of the central government, will continue to reference the new issue levels of its peers such as EIB and KfW", said Patrice Ract Madoux, its chairman, recently. The exact relationship is, however, variable: the spread between these issuers is impacted by the amounts of debt they each have to raise. When Cades announced a reduced funding requirement some years ago the spread between its outstanding debt and that of its peers contracted, which was logical given the reduced issuance prospects. This year, following the announcement in January that it will assume further debt, the spread differential has remained relatively stable. This can, in part, be attributed to the higher supply needs of other issuers such as the EIB, KfW and SFEF relative to Cades. As a result one London based syndicate manager suggested that "Cades can't really be compared to these other agency issuers as the frequency of their issuance creates differences in the liquidity of their secondary debt distorting direct comparison." Last year Cades' funding programme was €8.6bn, which consisted of €3bn raised through euro benchmarks and €3.5bn in US dollars and Australian dollar benchmark deals. When Cades announced the increase in its funding it presented two scenarios through which this might be achieved. The amount of short-term financing was the main variable between the two plans. Issuance in this maturity can vary between €6.3bn and €18.3bn, depending on its ability to raise medium to longer-dated capital this year, said Philippe Noel, head of capital markets. As a result, the amount of benchmark bond issuance is likely to be between €9bn–€15bn for new euro benchmark trades and €2.4bn–€3.9bn equivalent for US dollar benchmark deals this year. The balance will be raised through taps of existing deals – something it has not done in the past and which could amount to €1bn–€2bn – and through other currency and inflation-linked bond issuance. By the end of the first quarter Cades had completed €8.2bn of its funding needs after selling its largest two-year Eurodollar deal, a US$2.25bn April 2011 trade at mid-swaps plus 45bp. As with its previous two-year deal in February, which was priced at mid-swaps plus 30bp, Cades was able to maximise the benefit of the euro/US dollar basis swap which was worth between 45bp and 50bp for these deals. When Cades sold its €2bn 2.625% April 2012 deal in January it achieved a mid-swaps plus 20bp pricing level. "The ability of other borrowers to access the 15-year sector of the market might be seen as a helpful development as it may enable us to consider the option of issuing longer," Noel said at the time, underscoring the issuer's intention to move to a longer-dated issuance profile when market conditions permitted. By February Cades was able to add €900m to its outstanding €1.5bn 1.85% inflation-linked July 2019 issue at 58bp over the reference 1% OATi July 2017 – the largest increase ever done by Cades for a bond indexed to French inflation. Subsequently, there has been a €550m tap of the 4% October 2019 deal at mid-swaps plus 58bp, bringing the total outstanding to €4.1bn. Cades also added €650m to its 4.375% October 2021 deal at mid-swaps plus 63bp in March.