Public sector issuers plot path through tricky 2013
* Issuers look to longer maturities to meet yield hunt
* Two-way CSAs predicted to come to a head after UBS exit
* Markets more immune to ratings downgrade after wave of cuts
By John Geddie
LONDON, Dec 20 (IFR) - Public sector issuers will have to adopt a nimble funding strategy in 2013 as they navigate a triple whammy of an investor flight to higher-yielding products, potential rating downgrades and increased regulatory pressure on their counterparties.
Investors have made sizable returns this year as spreads across the sector have consistently ground tighter, but at current levels those returns will be near impossible to match in 2013.
As a result, public sector borrowers would prefer to issue longer-dated bonds in benchmark currencies which offer more yield rather than simply having to accept higher costs of funding by paying hefty new issue premiums to entice investors.
"The low yield and spread environment is making it very challenging for investors, and likewise for us to be able to provide the right products," said Eila Kreivi, head of capital markets at the European Investment Bank (EIB).
The key is flexibility, other issuers say, whether in regards to timing, number of deals, issue size, maturity or currency. Keeping a hand in every local currency market that offers arbitrage opportunities will also be vital.
"I'd rather have a strong USD1bn deal than have to pay up aggressively in order to generate a USD2-3bn book that could be to the detriment of IFC's outstanding curve," said Ben Powell, senior financial officer at the International Finance Corporation.
The broad consensus in the market is that five-years will be the maturity of choice in 2013 for SSA dollar bonds versus three years in 2012. Similarly in euros, issuers may look to push out to seven-years if there is too much congestion at the short-end.
For many issuers that will come at considerable cost given the inherent steepness of their curves. For example, EIB's euro credit curve has steepened around 20bp over the course of the year between its five- and 10-year bonds.
Another potential headwind for issuers is further ratings action, especially in Europe.
Triple A rated Dutch agencies Bank Nederlandse Gemeenten (BNG) and Nederlandse Waterschapsbank (NWB) are just two of the borrowers currently waiting on tenterhooks after they were placed on CreditWatch negative by S&P in mid-November.
Both issuers remain uncertain about how the potential loss of their coveted ratings - expected to be announced by mid-February - will impact investor appetite for their debt, especially as the sovereign is still likely to be rated Triple-A at that time.
"The announcement was made when we were roadshowing in Asia, and the initial feedback from central banks was very promising," said Bart van Dooren, head of funding and investor relations at BNG.
"However, we also understand some asset managers only have the mandate to invest in credits with three Triple A ratings."
Most of Europe's few remaining Triple A rated sovereigns and supranationals are now on negative outlook by at least one of the ratings agencies. France was downgraded to Aa1 by Moody's in November, prompting the same action on its government-backed agencies, as well as eurozone bailout vehicles EFSF and ESM.
Fortunately for issuers, the market appears to have become less sensitive to ratings cuts. France's long-term borrowing costs even hit a record low at a December auction following the downgrade as investors favoured its relative safety.
Banks - the sector's most loyal customers - have also developed sophisticated risk assessment models which are only partly focused on ratings.
SWEATING ON SWAPS
Although banks will underwrite lower-rated SSA deals, swaps are another matter, and banks are piling more pressure on issuers to rethink their asymmetric swap arrangements, following the shock exit of UBS from the SSA business in October.
UBS's legacy swaps portfolio, and its diminishing returns, are widely believed to be one of the reason for its decision.
When the news broke, syndicate desks across London reportedly picked up the phone to warn issuers that if they did not start to share the burden of swap costs then other banks would also exit.
As things currently stand, the majority of SSA issuers have one-way credit support annexes - contracts that require banks to post collateral to these issuers when out-of-the-money on swaps, while not receiving collateral when the situation is reversed.
"UBS was very much focused on growing market share, an approach which other houses also took, but one that is not followed anymore," said Petra Wehlert, vice-president and head of new public bond issues at KfW.
"Every bank has to focus on making the business profitable; market share or league table trades are no longer as important as they once were."
Banks have inched up quotes on swaps for their clients, hoping this will force issuers into two-way agreements. The UK's Network Rail has moved to two-way CSAs, and a breakaway group of Washington supras is also heard to be nearing a decision.
Issuers with the largest programmes, however, have not budged, but this should come to a head in the next year.
Whether there will be more shock exits remains to be seen, but UBS' departure has certainly reinforced one age-old adage - always expect the unexpected.
"I don't foresee that other banks will pull out, but then again UBS's departure came as a surprise to everyone and could not have been predicted," said van Dooren at BNG.
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