IFR Triple A Borrowers Report 2009

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

General Electric finally fell from its theoretically significant Triple A rating in March when S&P lowered downgraded the credit a notch to AA+ before Moody’s struck with a two-notch relegation to Aa2. The move was certainly not welcome for the conglomerate. But now that it has a stable credit outlook, investors value the implied stability. In many ways, it was a godsend for GE. GE reached a 52-week low on March 4 of US$5.73 as uncertainty about GE and, in particular, GE Capital, its struggling lenders, drove investors away from the once stalwart credit. Since then shares have rallied to around US$13.00 apiece. Yields on its most actively traded bonds also tightened by about 100bp. The immediate improvement in the company’s stock and bond position after the downgrades in part reflects the pessimism about GE that preceded it. The company had been forthright about its own woes, apparently leading investors to believe that the rating agencies would be more severe on decision day. When it came, the downgrade was a relief. Crucially, it showed how highly investors value concrete information in this market, even if it is not completely positive. But there could be worse to come. Despite GE Capital's success in the government-backed capital markets, it is still perceived as the problem. While GE's industrial business has indeed been weakened by the economy, it was specifically GE Capital's financial woes that drove the decision to downgrade. In fact, Moody’s said that GE Capital as a standalone would carry a mid-Single A rating. GE said that the impact of the new ratings would be minimal. It has already met more than 90% of its 2009 long-term debt needs and lowered its commercial paper outstandings to US$60bn from the US$88bn it owed in the third quarter of 2008. "As we have previously said, we are prepared to fund the company as a Double A, but we will continue to run GE with the disciplines of a Triple A company, which means low leverage, high liquidity and strong risk disciplines," said Jeff Immelt, chairman and CEO, at the time of the downgrades. "While no-one likes a downgrade, this review and rating reaffirms the relative strength of the company." Before the downgrade, a Citigroup report estimated that should long-term credit ratings go below AA– (two notches below the current AA+) or the short-term rating fall below A1+/P1, GE would have to pay US$8.1bn to support guaranteed insurance contracts. If short-term ratings fall below A-1/P-1, the company will be forced to retire US$3.8bn in CP and access to the Fed's commercial paper funding facility will be cut off. Yet this year GE (and GE Capital) have not performed as poorly as expected. For the first quarter it recorded a profit of 26 cents a share, beating Deutsche Bank’s expectations by four cents. Yet by its own long term standards the company’s performance is sub-standard: earnings from continuing operations were US$2.8bn, down 35% from the first quarter last year, while revenues were US$38.4bn, down 9% year over year. No guarantee necessary Investors have been concerned about GE’s prospects for some time. Early this year the company sought to put to rest speculation that its GE Capital division wasn’t viable. In fact GE Capital became the first issuer backed by the Temporary Liquidity Guarantee Program (TLGP) to price an offering in the unguaranteed market since the bond backstopping program started in November. In January, after starting the New Year with a US$10bn guaranteed deal, it hit the tape an SEC-registered 30-year fixed-rate global MTN issue. GECC and its bankers answered investors demand for FIG long bonds and priced the deal with a nice concession. Not since American Honda's two-part US$1.25bn offering on September 24 2008 had there been an unguaranteed FIG-type issue. That came at 387.5bp over Treasuries for an Aa3/A+ rated deal. Despite the eventual downgrades, the deal was a significant vote of confidence for GECC. "They're a wholesale funder," a syndicate o

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.