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Western EuropeJuly 5 2010

Nimble KfW tests euro demand

In the face of heightened debt market volatility in Europe and serious concerns over the long-term future of the euro, German development agency KfW found a window of opportunity to raise €5bn in a three-year deal. Writer Charlie CorbettKfW's treasurer, Dr Frank Czichowski
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Nimble KfW tests euro demand

The European debt markets over the past two months have resembled a ghost town. Sceptical investors turned away from the region after simultaneous fiscal storms battered the continent and wary issuers are keeping the hatches firmly battened down.

Every issuer except one. German development agency KfW took the bull by the horns and chose to issue a €5bn three-year deal at this deeply uncertain time. As the Greek fiscal tragedy and struggling PIGS economies (Portugal, Ireland, Greece and Spain) sent shudders down the spines of investors in Europe, so KfW decided to test the strength of the euro and the supposed scepticism of investors.

"Everybody in the market was concerned, there was a lot of discussion around the euro and what were the consequences of the recent instability on the demand for euro-denominated issues," says KfW's treasurer Dr Frank Czichowski. "We were convinced [the deal would be a success] because overall there was a lack of supply at the short end of the curve and very strong demand for German credit." He adds that although volatility stalked the market, he was confident the deal could be pulled off. "People were looking for a safe haven and that is what we offered them," he says.

Bold move

Not many issuers would have attempted to raise such a large amount at such a volatile time. However, a AAA rated agency with a gold-plated guarantee from the Federal Republic of Germany has a better chance than most of pulling off a €5bn deal.

"This was the right instrument for the time, and we were proven right," says Mr Czichowski. It should also be remembered that KfW, on behalf of Germany, is stumping up €22.4bn of the €110bn EU/IMF bailout of Greece. Despite this, the development agency has not increased its €75bn annual funding programme, of which this deal is a part.

The depth of market nervousness was felt throughout the process and the bookrunners - Bank of America Merrill Lynch, Commerzbank and UBS - managed only a modest over-subscription when compared to previous KfW issues. The deal attracted €5.8bn of demand from investors, which compares to up to €10bn of demand for similar-sized former KfW issues. The deal offered a coupon of 1.25% and priced at 20 basis points (bps) through mid-swaps. This made it one of the tightest three-year deals achieved in euros.

Investors were not put off by the tight pricing because the deal offered a big yield pick-up of 74bps over the 2013 bund, a fact that pleases Mr Czichowski. "The bund performed extremely well [during the course of the deal] and we were able to offer a very attractive spread," he says. This drove investor demand and attracted interest in the deal from all over the world.

Interest from Asia

Mr Czichowski was particularly happy with the take up from Asia, which was up from 7% of the previous KfW issue to almost 20% on this occasion. "The perception that investors outside of Europe were turning away from buying euros was clearly wrong," he says. "The market was relieved that there was significant demand for euros. Investors are not quite as sceptical over the prospects of the currency as some of the doomsayers say."

Despite the success of the deal, it did not come without its challenges. Mr Czichowski says that the hardest part of having a long-term funding programme with a volume of €75bn a year is that investors know there will be another KfW issue coming again in the foreseeable future. "Nobody is forced to buy a KfW security at a particular point in time. It's different from a corporate investor which might issue only every other year," he says. "Making the 20th benchmark as interesting as the first is the challenge we have for these benchmark programmes."

Timing was also a critical element to issuing at such a volatile time. "We had to look even more carefully than in the past to identify the right window of opportunity to issue the security," says Mr Czichowski. "The volatility in the market prevents you from doing very long-term announcements as far as issuance is concerned. You can't announce an issue a week in advance." In the case of the most recent deal, Mr Czichowski says KfW was forced to be "very flexible and quick", which meant the deal had to be priced within a limited time frame.

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