The Future of Capital
Top quality issuers boost debt capital markets
Forget the broken banking system
While the global banking system, households and corporations, all now struggle to reduce borrowing, it has been left to governments to lever up to compensate, borrowing heavily to raise funds to support the liabilities of weakened banks and to provide economic stimulus. Away from emerging markets that fund heavily in foreign currency, there is a widespread assumption that government debt is risk-free.
That view might be challenged in the capital markets this year, as investors price in huge new supply.
 |
"Credit investors have never been worse off. They’re licking their wounds. So a great deal now hangs on traditional rates buyers"
Roberto Isolani, UBS |
"If you look at the supply side of the equation in the debt capital market," says Roberto Isolani, joint head of global capital markets at UBS, "we are still adjusting to the disappearance of the leveraged investor base that previously drove spreads to their historical lows. Hedge funds used to provide the bulk of demand in the primary market – from a half to two-thirds. But no more. Credit investors have never been worse off. They’re licking their wounds, seeing huge redemptions and, while secondary markets are so dislocated, they’re not particularly interested in the primary market.
"So a great deal now hangs on traditional rates buyers."
Companies will have to look to collateralizing assets on their balance sheets to gain some liquidity. This may support the ABS markets in 2009. Bankers also expect financial institutions themselves to keep producing ABS deals, if only so as to post them as collateral to central banks. Deals might go up on the screen but many will never be placed with a single end investor. So while the US Treasury is rumoured to be considering allowing the Federal Reserve to issue government debt in its own right, concerns are growing at the quality of assets on its balance sheet that such new treasury liabilities might fund.
There is only one way to attract credit investors back to the unsecured corporate and bank markets, suggests Isolani. Rates will have to go up and curves steepen.
And meanwhile look out for the so-called risk-free markets. Bankers will repeat until they are blue in the face that debt capital markets remain open to governments, to government-guaranteed issues and top-rated banks and corporates. But their confidence in such proclamations is stretched.
Isolani says: "It is not immediately obvious to me that there really is sufficient demand for all these top-rated, government and government-guaranteed and public-sector issuers. The potential supply is simply huge. An equilibrium price will no doubt be found but it will have to be at higher spreads (against Libor) than the current ones."
Another banker is struggling with the same worry. "When I think about the potential supply from the public sector, the word that keeps popping into my mind is ‘infinite’."
Paul Hearn, global co-head of origination and distribution, fixed income at BNP Paribas, points out. "Look at some of the central banks that have been the mainstays of the rates market. The Korean and Russian central banks for example have been using foreign currency reserves in a number of ways, including defending their currencies. Are they going to be as big participants in the rates markets as they were? Maybe not."
|
Cost of protection against default for sovereigns |
|
Five-year CDS spreads |
 |
|
Source: IIF |
He offers a further warning about what the government-guaranteed bank market is saying about the guarantors themselves. "In Europe we have seen initial euphoria give way very quickly to repricing. Now, governments want their national champions to issue first using their guarantees to set a low benchmark. As an example, the first bank out of one country came at 45bp over midswaps and the second a couple of weeks later at 80bp over. They were very different issuers but it was the same guarantee."
Legacy government bonds may continue to benefit from their traditional values of liquidity – at a time when liquidity is at a premium everywhere – and historical status as instruments for trading interest rate risks, deliverable into rate futures. But in the credit default swaps market and in the new government-guaranteed bank bond markets, something worrying is stirring. CDS spreads are widening for US and other developed world governments. Are these rising spreads the more rational and pure market view on credit fundamentals. If so, how will such pricing affect future government debt raising?
One banker says: "We are one of the advisers to the UK government on this and I can tell you that the debt office is very conscious of the risk of doing too much to support the banks, but equally conscious of the risk of doing too little."
Jim Amine, co-head of the global investment banking department at Credit Suisse, says: "For governments, running large programmes of government-guaranteed debt is still probably the right thing to do to stabilize the [banking] system but it’s going to crowd other issuers out of the market."
There is a growing sense of governments acting like mice on a wheel. They are guaranteeing bank funding. Banks are pumping it out. Who is buying it? Other banks, apparently. One DCM head says that banks buy at least one-third of all government-guaranteed bank deals, with his desk’s first call usually being to HSBC, which has a reputation for placing huge orders.