A EUROMONEY SURVEY – MARCH 1996
Niche market offers select investment opportunities
After rapid growth in the past few years – driven mainly by budget deficit financing – prospects for foreign investors in the Nordic bond markets look increasingly dull. One of the biggest problems, despite growth, is size. For example, by 1994, the four markets (Denmark, Finland, Norway and Sweden) had publicly-issued bonds of around $550 billion; but government bonds only amounted to $17 billion in Norway, $20 billion in Finland, $77 billion in Sweden and $90 billion in Denmark, making a total of only around $200 billion. Moreover, the major local banks – which dominate these markets – have little interest in fostering their development because they make more money lending to clients than arranging bond issues for them. As a result, most Nordic bond markets remain small, insular and unsophisticated by international standards. For example, the Swedish Export Credit Corporation (SEK) recently launched a Skr1 billion ($146 million) 10-year domestic bond offering. SEK, half-owned by the Swedish government and half by local banks, is one of Sweden’s top-quality credits and a frequent visitor to the Eurobond market. Nevertheless, its bonds were priced at a generous 17 basis points (bp) over the government benchmark and, as extra inducements, SEK provided spread and liquidity guarantees, promising to buy back the bonds from investors at any time at no more than 20bp over. However, there was virtually no interest from the market and SEK was forced to withdraw the offering. Sweden’s giant National Pension Fund and other local institutions were simply not prepared to consider investing in anything other than government and mortgage bonds.
The Norwegian bond market is the smallest in the region “and not likely to become much larger” in the near future, says a London-based banker. That’s because Norway, dubbed “the Kuwait of Scandinavia” by some, will generate budget surpluses starting this year and its government no longer needs to borrow except to redeem maturing bonds. “They’re doing their best to keep liquidity in a small number of issues, repaying foreign debt and issuing bonds in domestic currency, buying back some less liquid bonds from domestic institutions and issuing some benchmark issues,” this banker adds.
At the end of 1994, there were NKr310 billion ($45.8 billion) of publicly-issued Norwegian krone bonds outstanding, 0.2% of the global total, Salomon Brothers calculates. Central government bonds accounted for NKr111 billion (36%), while mortgage banks accounted for 24%. The government is expected to refinance about NKr60 billion to NKr80 billion of maturing bonds over the next couple of years, with a projected net new supply this year of close to NKr20 billion. Foreign participation in the market is estimated by Den Norske Bank at only 2% or 3%, partly due to the low liquidity, difficult access and lack of a repo market (a gap which the central bank hopes to fill this year).
Last year, Norwegian government bonds delivered a 16.7% return in local currency and 24.9% in dollars, according to Salomon. They have the lowest yields in Scandinavia, with 10-year spreads over Germany ranging between 60bp and 75bp as of late February. But short-term spreads were about 200bp, much higher than those in Denmark and Finland, apparently reflecting the central bank’s determination to maintain currency stability. Going forward, analysts cite Norway’s over-dependence on oil as a principal risk, along with the danger of increased government spending in the approach to the 1997 general election.
Finland’s small market has doubled in size since 1990. At the end of 1994, there were Fmk208 billion ($43.9 billion) of publicly-issued Finnish markka bonds outstanding, 0.2% of the world total. Central bank figures show that domestic bonds outstanding increased to Fmk231 billion as of last October. Central government bonds accounted for Fmk136 billion (59%), financial institutions for 33%. Merita Bank estimates that the government’s net borrowing requirement will fall from about Fmk68 billion in 1995 to around Fmk40 billion this year and further still next year.
Foreign participation in the market is estimated at between 12% and 14% of the benchmark stock. It was much higher when Finland was regarded as one of the high-yield markets, but declined as yields fell and foreign investors took profits. “We lost investors on the way down,” says a banker in Helsinki. However, Finland should gain a higher profile as a result of several developments this year: the country is expected to join the ERM, the authorities hope its credit rating will be upgraded by a major rating agency, Salomon will add Finland to its World Government Bond Index (albeit with a very modest weighting) – Denmark and Sweden are already components – and Finnish institutional investors may be allowed to participate in the repo market.
Last year, Finnish government bonds provided a 19.6% return in local currency and 30.5% in dollars, according to Salomon, as yields plunged in response to the country’s sharp economic turnaround and conquest of inflation. In January this year, yields on 10-year government bonds fell below those in Denmark, and spreads over Germany, which had been more than 290bp last March, hovered around 100bp. Some analysts think Finland is fully valued at this level: others see room for further tightening. The main short-term risk is that the government might relax fiscal austerity in the hope of reducing unemployment, given its pledge to cut the jobless rate in half, which could have an adverse effect on inflation and interest rates.
Denmark has the largest bond market in Scandinavia, with Dkr1.5 trillion ($251 billion) of publicly-issued Danish kroner bonds outstanding at the end of 1994, or 1.4% of the world total, according to Salomon. Government bonds accounted for Dkr553 billion or 36%, while mortgage credit bonds accounted for 56%. The government is expected to issue about Dkr103 billion in the domestic market this year – Dkr36 billion less than in 1995. Last year, Danish government bonds generated a return of 18.9% in local currency and 30.6% in dollars.
Foreign participation reached about 40% in early 1994 but then sank to around 25% in a major sell-off as global interest rates rose. However, confidence returned late last year and foreign holdings are again close to record levels, reaching about 37% at the end of last year and increasing since then.
Some observers wonder why Denmark’s long-term spread remains so high, given that in recent years its economy has performed better overall than the German economy. Conventional wisdom holds that it is paying a risk premium stemming from uncertainty over EMU (it has not yet decided to join and has the right to opt-out). But not everyone thinks this is justified. “Our bond market is less liquid than Germany’s: that costs us something like 25bp,” says Henrik Normann, senior vice-president at Den Danske Bank in Copenhagen. “But our right to opt-out of EMU could be advantageous. If it is perceived as Denmark maintaining its flexibility, rather than something negative, you could see Danish spreads go down to about 75bp over Germany.”
On the other hand, he concedes: “We are still paying for the sins of the past”. With its continuing need to borrow, the Danish government cannot drive spreads down too far in case foreign investors lose interest in its paper and, since they already own more than 37% of its bonds, their opinion carries weight. In general, Normann thinks spreads will move in line with broader market sentiment. “My view is that, in smaller markets such as Denmark, you tend to see spreads narrowing against Germany in bull markets: when investors are positive, they look for a yield pickup. So if this bullish trend continues, we can sustain these low interest rates.”
Foreign investors only own about 2%-3% of Danish mortgage bonds, partly because issuers have traditionally not sought long-term credit ratings. But last year, Unibors arranged the country’s first collateralized mortgage obligation (CMO) issue, a Dkr2.5 billion offering of 14-year callable bonds in seven senior and junior tranches; part of the senior debt was rated double-A by Standard & Poor’s and placed with foreign investors. Encouraged by the success of this issue, and subsequent healthy turnover in the secondary market, Unibors expects to launch several more CMO offerings this year. Meanwhile, there is speculation that mortgage bond issuers will obtain long-term credit ratings shortly.
The Swedish bond market is almost as large as its Danish counterpart but has not yet regained widespread favour among foreign investors, despite the region’s highest yields. At the end of 1994, there were Skr1.6 trillion ($210 billion) of publicly-issued Swedish krona bonds outstanding, 1.1% of the world total, Salomon estimates. Central government bonds accounted for Skr577 billion (37%), housing credit institutions for 53%. Foreigners held just under Skr100 billion of the roughly Skr700 billion of marketable local-currency government bonds outstanding in January this year (around 15%), compared with about 40% before a big sell-off in 1994. Bankers in Stockholm say that underweight foreign fund managers are slowly starting to return.
By pulling out, foreign investors missed the world’s top performance in 1995, with Swedish government bonds advancing 20.2% in local currency terms and 34.8% in dollars according to Salomon. As sentiment about Sweden has begun to turn, 10-year spreads over Germany have eased from a peak of over 450bp last April to around 210bp in January this year, before rising back up to the 240bp-250bp range. However, the spread remains much wider than for any other Nordic country, indicating ongoing market concerns about Sweden’s economic prospects. Some analysts think the long-term premium may decline to 200bp or lower by the end of this year: all expect short-term spreads to fall sharply as monetary policy is relaxed. With two-year government notes trading at about 400bp over Germany in early January, some bankers saw this as the most promising Swedish investment opportunity.
The Swedish government is expected to borrow Skr60 billion to Skr70 billion this year, of which the Swedish National Debt Office (SNDO) has been mandated to raise at least Skr20 billion in foreign currency. The latest borrowing requirement is far below the 1993-94 peak of Skr208 billion, but some analysts believe it will rise again next year. In addition to cost-effective borrowing, the SNDO’s primary goals are to improve the liquidity of its debt, to smooth its maturity profile and to extend the (unusually short) maturity of its debt. Under a more active director general (former central bank deputy governor Thomas Franzen who took over last September), the SNDO has launched several innovative initiatives. Since January, it has offered index-linked zero-coupon bonds on tap, which have proved highly popular; late last year it exchanged maturing bonds for longer-maturity paper; and recently it swapped Swedish krona debt for US dollar debt for the first time, using low-cost domestic funding to create cost-effective foreign currency funding (in this case, saving about 15bp over the cost of regular dollars).
Sweden clearly has further to go in pursuit of sound public finances, debt reduction and meeting the EMU criteria. Analysts say the main risks are that the new prime minister (who won the market’s confidence as finance minister) might adopt expansionary fiscal policies for political reasons or to counter flagging growth, that an early recession might undermine progress or even trigger a new downward spiral and that the central bank could cave in to political pressure – it is a quasi-political institution, with members of parliament on its board. Sweden’s poor historic inflation record also weakens its credibility.
Danish kroner drives Nordic Eurobond issuance
Nordic currencies hold a small part of the Eurobond market, with the equivalent of around $10 billion outstanding at the end of 1995. Few borrowers outside the region need these currencies and swap opportunities are limited. Nevertheless, last year saw a record volume of Danish kroner issues – partly driven by investor demand for higher yields in a stable currency – and some bankers think the same attractions could fuel an increase in Swedish krona placements this year.
Some trace the origins of the Eurokroner market to 1985, when Unibank arranged a Dkr250 million 10-year issue for the European Investment Bank (EIB). But annual issuance peaked in 1987 at Dkr10.7 billion and, according to Salomon Brothers, the total amount outstanding reached a high of Dkr28.9 billion in 1989 before falling to Dkr20.5 billion at the end of 1994, of which 80% represented issues by Danish borrowers. Last year’s record 38 issues totalling just under Dkr16 billion and a steady trickle of new offerings early this year have probably taken the amount outstanding to new heights.
Many of last year’s borrowers were German or Benelux countries, although the Kingdom of Sweden also launched three Eurokroner issues raising Dkr1.3 billion for three, five and six years, with Kredietbank managing two of the deals and Banque Bruxelles Lambert the third. As these names suggest, Eurokroner bonds are largely placed with Benelux and German retail investors who value the Danish currency’s stability against the Deutschmark and because they can yield as much as 100bp more than Deutschmark bonds. For non-Danish borrowers like Sweden, the main attraction is usually a cost-effective swap opportunity.
The other principal currency in the Nordic sector of the Eurobond market is the Swedish krona, with the stock of Eurokrona issues outstanding growing from less than Skr1 billion in 1986 to Skr27.5 billion at the end of 1994 – of which about 41% represented Swedish borrowers. Issuers placed 19 offerings totalling a record Skr14.2 billion in 1994. In recent years, Swedish krona borrowers have included some of the Euromarket’s top names, including the World Bank, the IFC, the EIB and the European Bank for Reconstruction and Development (EBRD) as well as numerous European banks and industrial companies.
However, issuance dried up last year, with only three publicized transactions totalling Skr2 billion – a Skr1 billion 10-year final maturity (five-year expected) securitization for the City of Stockholm housing companies by ABN Amro, a Skr500 million four-year deal for Commerzbank by SBC Warburg and a Skr500 million four-year issue for the Swedish Export Credit Corporation (SEK) by Svenska Handelsbanken. The SEK issue was priced between 2bp and 3bp over Swedish government paper, representing a spread over short-term Danish bonds of about 200bp. This differential could attract more retail Benelux investors into Eurokrona bonds this year if the krona is seen as stable.
Elsewhere, Eurobond issues denominated in Finnish markka have grown feebly in recent years, with the total amount outstanding peaking in 1991 at Fmk9.6 billion and falling to Fmk7.2 billion at the end of 1994. There was one new issue in 1992, two in 1993 and seven in 1994, of which five were convertibles, one was a floating-rate note and only one was a fixed-rate bond – a Fmk2 billion five-year global issue by Finnish Export Credit with Goldman Sachs as lead-manager. There were no publicized issues last year, but in January this year, CIBC/Wood Gundy organized a Fmk100 million five-year offer for the Nordic Investment Bank.
The market for Eurobond issues in Norwegian krone was effectively in limbo until late last year, with the total amount outstanding peaking at NKr3.5 billion in 1985 and falling thereafter to NKr300 million at the end of 1994. But last year’s market liberalization has re-opened the sector. Recent deals include the Kingdom of Sweden (a NKr1 billion 10-year offering last November) and a NORDIC BOND MARKETS r500 million five-year offer by Statkraft (a Norwegian energy producer) in late February.
