Needed: a strategy for uncertain times

KfW, one of the public sector market’s largest and most liquid borrowers, was faced with a particularly daunting task this year.

The state-guaranteed development bank has seen its borrowing needs shoot up in a year when macroeconomic headwinds, political disruptions and hefty monetary policy measures are all pulling the market this way and that.

So far, the issuer has forged ahead with the programme, helped initially by a flight-to-quality bid and later by additional stimulus measures announced by the European Central Bank.

As the year wears on, however, there are further potential disruptions and hurdles to be negotiated.

KfW said at the end of last year it is to borrow an additional €12.5bn in the bond market in 2016 as economic growth in Germany and Europe boosts demand for the agency’s promotional loans.

Europe’s largest economy recorded growth of 1.7% growth in GDP in 2015 and would have recorded a similar or slightly larger figure for 2016; but a short-term boost from the refugee situation could push this figure up to 2%, a KfW economist told IFR.

“Our educated guess is that the GDP boost related to the refugee influx will account for approximately a quarter of a percentage point of 2016 GDP growth. It would have been 1.7%–1.8% without this,” said Klaus Borger, principal economist, KfW Bankengruppe.

The boost arises from the money that the government will spend to help manage the situation, which essentially will act like a fiscal stimulus.

KfW, which helps the German government achieve its goals in development policy and international development cooperation, was expecting to be extra busy in 2016 against this backdrop of growth.

The Triple A rated borrower announced late last year that its long-term funding programme for 2016 would be between €70bn and €75bn, compared to the €62.5bn raised in 2015.

After a rocky start, the issuer has grown into the year, pricing some impressive trades in recent times. Yet the path ahead remains uncertain.

Jumping right in

This hefty need may have been what pushed KfW to forge ahead at with its programme at the start of the year, when many other issuers stood on the sidelines.

The macro environment was far from conducive. Worries over Chinese economic growth, or lack thereof, and an oil price disrupted by alarming news from the Middle East led to a panicked market tone. Equities fell off a cliff and credit markets wobbled alarmingly.

Against this backdrop, KfW flew out of the traps in the very first full week of the year with US dollar and euro trades, though with differing levels of success.

It started off, understandably, with a defensive trade in dollars, a three-year benchmark Global.

Despite the short tenor, there were still question marks over investor demand. Swap spreads went negative in the latter half of 2015 and remained negative in anything but the shortest part of the US dollar curve at the turn of the year.

Thankfully, it appeared that the German agency had set the price just right: it recorded an order book of over US$7.5bn for its first deal of the year and ended up printing a US$5bn 1.50% February 2019 bond.

A final spread of 21bp over mid-swaps, suggesting a 6bp new issue premium, was certainly a lot higher than the kind of levels it has priced at in the recent past. In January 2015, for example, it printed a US$3bn January 2018 bond at 5bp through mid-swaps and a marginal new issue premium.

This difference in price, concession and size all showed not only how the market had changed but also how KfW had evolved its approach, and the reward for its pragmatism was a solid start to the year.

It did not have long to bask in the warm glow of the deal’s success, however. A warning came later the same week.

The development bank’s first euro benchmark trade of the year proved a bit of a slow-burner, with the issuer struggling to get to the €3bn of orders required to print what it would deem a normal benchmark size.

KfW opened the book on the seven-year euro trade, and by the time it set the final spread, it only topped €2bn. It was well after midday when the book hit €3bn excluding lead manager orders, allowing the issuer to gratefully print a €3bn 0.375% March 2023 deal.

“It has very much been a slow-burner rather than a blowout trade, but a book of over €3bn is actually pretty successful given the underlying volatility,” said a lead banker at the time.

The euro market of the time was sluggish, not just because of the macro environment but also on the back of a December ECB meeting that resulted in disappointment for those expecting it to announce a raft of new initiatives. This was to change at the end of January, when the central bank’s president, Mario Draghi, dropped heavy hints of strong stimulus measures and then subsequently came good on those intimations in March.

But before it could take advantage of this sudden improvement in the mood in the single currency market, there was another benchmark US dollar excursion to deal with and, once again, KfW took the pragmatic approach.

The agency attracted over US$5bn of demand for a new five-year dollar deal in February, but the choice of currency came at a cost. The US$4bn March 2021 trade priced at a hefty mid-swaps plus 44bp spread.

That level equated to around 13bp through mid-swaps in euros. Next to KfW 2021 euro deals, which were bid on Tradeweb in the mid-swaps less 20bp range, it showed the issuer was paying up versus its native currency to access dollar funds.

Draghi game-changer

By the time March arrived, expectations that the ECB would “kitchen sink” the market had made its mark and KfW deemed it the right time to test out the 10-year tenor, hitherto considered a tricky one. But with yields shrinking at a rapid rate and investors hastily moving further up the curve, the deal proved an extremely well-timed venture.

“It was a very tricky duration at the start of the year for agencies but now it is wide open,” said one DCM official away from the deal at the time. “Now is the time to take advantage and do these deals – it is the right decision from KfW.”

There was no question of struggling to find €3bn for this one, and the agency eventually priced a €4bn 0.375% March 2026 trade that won praise across the market.

By this stage, KfW had raised almost €22bn, which represented around 30% of its requirement for the year. It was well behind European Investment Bank, which was fast approaching the halfway mark in terms of its funding target, although the German agency professed itself satisfied.

“This is exactly where we wanted to be at this point in time, so our funding progress is pretty much in line with previous years,” Otto Weyhausen-Brinkmann, head of new capital market emissions team at KfW’s financial markets department, told IFR at the time.

“There is no change in our funding strategy for 2016: we will again spread our funding volume across the calendar year; however, given the recent volatility events, for us the micro timing is more important.”

Monetary policy became a factor in the US dollar markets as well, with dovish comments from Federal Reserve chair Janet Yellen pushing swap spreads back. SSA paper began to tighten in and issuance became attractive and easier to achieve.

This was particularly noticeable when KfW returned to the market for its fourth benchmark of the year. It resisted the temptation to go long – with the 10-year part of the curve showing signs of life again – and instead chose the most liquid and conducive part: the short end.

This proved unequivocally to be the right choice and it printed its largest deal in recent times, a US$6bn 0.875% April 2018 trade.

Future distortions?

The issuer is confident it is well on its path to completing its programme.

“I don’t foresee any larger hurdles to completing our funding needs this year. KfW has a very flexible, global funding strategy and market conditions are quite strong at the moment,” said Petra Wehlert, head of capital markets at the German agency.

“There might be more volatility in the markets going forward, but we have built up our access to both core markets [over] many years, so we can always focus more on the US dollar side if the market support there is strong, and the euro market is our home market anyway.”

While recent deals point to strong conditions for issuers, this happy state of affairs may not continue. The last time there was an ECB-fuelled rally in the market, there was also a reckoning to be paid.

First of all, levels grew so tight that the likes of KfW and EIB struggled to get benchmark deals done, with real money investors eschewing bond markets altogether. At one stage KfW’s bonds famously dipped below German bunds, an absurd state of affairs that is fast becoming the subject of SSA folklore.

Even more pertinently, the huge rally inevitably led to a sharp correction. Bunds fell off the proverbial cliff, with yields rising an alarming 70bp in a matter of weeks, leading to a panic sell-off across the entire European rates market and beyond.

Headline risks loom in the shape of a potential Brexit, Spanish re-elections and further issues in Greece. KfW may have further hurdles to cross before reaching its target.