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Supranationals face up to higher dollar funding costs
LONDON, Dec 7 (IFR) - Some of the richest names in the SSA sector may have to swallow the bitter pill of higher funding costs for their dollar issuance in the new year or turn instead to other currencies, as market participants predict a prolonged period of compressed swap spreads.
For the first half of 2012, Washington-based supranationals enjoyed attractive sub-Libor funding levels. However, since the Federal Reserve announced that it would extend Operation Twist at the end of June, five-year swap spreads have been on a relentless tightening path, moving from the high 30s to as low as 9.5bp. Since November, they have widened back out, but are still in the mid teens.
As a result, issuing in this most benchmark of maturities has become more costly for supranationals, as pricing brings barely sub-Libor funding and deals offer only a marginal pick-up over US Treasuries, making them less attractive for investors looking for yield.
Some of the transactions that have come in the latter part of the year highlight this change. A USD2bn five-year issue for the IFC back in April priced at mid-swaps minus 12bp, or 20bp over Treasuries, and attracted USD2.5bn of orders.
When it returned to market in November with a trade in the same maturity, the mid-swaps minus 4bp reoffer gave a mere 10bp pick up to Treasuries and the USD1bn deal only attracted USD1.4bn of demand.
A USD1bn five-year for the Nordic Investment Bank which priced flat to mid-swaps - equivalent to 17.05bp over Treasuries - struggled even more, coming short of full subscription.
FISCAL CLIFF RELIEF
Some SSA bankers hope that a resolution to the fiscal cliff could offer enough relief to even stave off the tightening effects of increased issuance in January.
"Macro forces like the fiscal cliff and uncertainty around US sovereign ratings are likely to have a greater impact on the swaps market than the technicals caused by the seasonal increase in new issue supply," said Dan Shane, head of SSA syndicate at Morgan Stanley.
Issuers with the most aggressive funding targets in the segment will obviously be following these events with some interest, but at the moment do not seem too panic-stricken.
"We think that, because absolute rates are so low, even tight spreads have an appeal to investors. In a higher rate environment, where the pick-up may be a negligible percentage of the return, this may not be so," said Isabelle Laurent, head of funding at EBRD.
Meanwhile, rating agencies demand that these institutions keep solid cash buffers to maintain their credit ratings .
"Pretty much every supranational you talk to has a very strong liquidity position right now, a lot have seen lower disbursements than they were forecasting, and are certainly in no urgency or rush to issue," a syndicate official said.
"They can look across markets to see if there are better opportunities in euros or sterling, but ultimately when that pressure mounts they will just have to pay the price," he added.
Should dollar swap spreads stay as tight as they currently are, it could lead heavy users of the dollar market to look more closely at alternative currencies.
The EUR/USD basis swap has narrowed dramatically with improving market sentiment around the eurozone, meaning it is not as expensive to issue in euros and swap back into dollars.
Since early June, the five-year cross currency basis has moved from minus 65bp to minus 34.75bp.
"We are not at that place yet, but you could conceivably get to a place where euros may become as attractive a funding tool as dollars," said Shane.
World Bank is the only Washington supranational with an outstanding euro bond - a 3.875% 10-year issued back in 2009. However, other supranationals are heard to be paying much more attention to the euro as a potential arbitrage currency.
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