No-one could claim that 2007 has been uninteresting. Unpredictable, maybe: uncomfortable, almost certainly: but uninteresting, definitely not.
From the first indications of problems in the US sub-prime mortgage market in early spring, there were market participants who were calling the end of the bull market run. There were also those, however, who pointed to previous hiccups in the relentless march forward over the past few years and how they eventually proved to present nothing more than temporary obstacles.
The beauty of the global market is that risk is spread across many different types of institution in all corners of the world: the danger inherent in the system comes from exactly the same source.
And while summer approached with little sign that anything of any great magnitude would come to pass, it appeared that the Cassandras would be proved wrong yet again. The rest, as they say, is history.
The fall-out from the ever-worsening situation in the US housing market was almost as swift as it was vicious. As the first non-US casualties became known there were clear signs that the crisis had struck at the heart of Europe. IKB was among the initial victims, the German bank almost certain to have been brought to its knees were it not for a rescue package put together by major shareholder KfW and its banking industry peers. It transpired that not only did it have significant direct exposure but that this was multiplied many times through a conduit holding.
With these conduits and SIVs dependent on short-term funding through the asset-backed CP market, the loss of confidence and consequent unwillingness of investors to buy such paper led to a liquidity squeeze that saw backstop bank lines as the only way that these institutions could continue to operate. This, in turn, put pressures on the banks themselves and, as the pool of cash evaporated, spreads lurched wider and liquidity evaporated.
This culminated in Northern Rock’s inability to secure sufficient funding and the ultimate run on the bank, meaning it was forced to turn to the Bank of England for help. Not caused directly to the sub-prime situation, its demise highlighted the knock-on effects inherent in a global system where asset classes and structures are interconnected, sometimes in surprising ways.
The major irony in the DCM world during the summer’s turmoil was that, while the majority of markets remained resolutely shut, the US continued to pump out and place paper in record volumes in spite of being at the centre of the storm. Confidence appeared greater closer to the heart of the problems, while much of the uneasiness had been exported.
For some perennial visitors to the Euromarkets, however, the crisis had only limited effect on account of their long-standing strategies finally being vindicated. Sovereign, supranational and agency borrowers have a long history of front-loading their issuance and 2007 proved no different. With much of their funding completed in the first half, any lack of demand was of only minor concern and their flight-to-quality status always acted as a backstop.
The same could not be said for financial institutions, the previous credit favourites consigned to the sidelines as risk aversion dominated. Signs in late September were that the markets were gradually reopening for them, however, with step-by-step forays into the senior sector, through LT2 and culminating in RBS’s mammoth multi-tranche Tier 1. But the senior floating-rate market could take some time to recover.
Corporates too began to return to the fold, as with FIG, the major difference being materially wider spreads and the move to an investor-driven market rather than one where issuers call the tune, as has been the case over the previous few years.
And this is the one major change that has come about as a result of the year’s turmoil: it is undeniably now a buyers’ market.
