Friday, May 1, 2009

World Bank Bonds Show What Happens in State Rescues

Federal guarantees by 13 countries on more than $400 billion of financial company bonds are punishing the AAA-rated World Bank Group with record borrowing costs -- an indication of what can go wrong when government gets in the way.

The Washington-based World Bank, founded in 1944 to rebuild economies after World War II, sold $6 billion of three-year notes March 26 priced to yield 30 basis points more than the benchmark for such borrowings. The so-called spread was the widest for a dollar-denominated bond offering by the supranational lender, said George Richardson, the institution’s head of capital markets, in an interview.

Just seven months ago, the World Bank paid a record low 35 basis points less than the midswap rate, a market measure for exchanging fixed- and floating-rate cash flows. The sudden rise in World Bank relative bond yields is an unintended consequence of sales of taxpayer-backed debt by more than 50 companies, including Goldman Sachs Group Inc., Bank of America Corp. and JPMorgan Chase & Co. While these special offerings were designed to bring stability to the credit markets after $1.4 trillion in losses and writedowns in the past 28 months, no one realized the World Bank would be depreciated by such government policies.

“Governments started announcing guarantees for their banks, and then the whole world changed,” said Richardson, a former Goldman Sachs banker.

Rising Sales

Rising risk premiums are also affecting the Washington- based Inter-American Development Bank, which lends to Latin American and Caribbean countries, and Germany’s state-owned Kreditanstalt fuer Wiederaufbau, whose credit supports housing, education and small business.

Banks and financial companies worldwide sold 320 billion euros ($424 billion) of state-guaranteed debt since October, denominated in euros, dollars and U.K. pounds, according to Leef Dierks, a fixed-income analyst at Barclays Capital in Frankfurt.

They may issue a total of 900 billion euros in bonds for all of 2009, Dierks said.

The total includes $235 billion of dollar-denominated debt in the U.S. with backing from the Federal Deposit Insurance Corp. as of yesterday, according to data compiled by Bloomberg.

Lenders backed by multiple governments, known as supranationals, have the flexibility to borrow billions in multiple currencies and at any part of the yield curve, making their bonds among the most liquid securities.

Financial Acumen

The financial acumen of the World Bank, which pioneered the first use of derivatives to obtain Swiss francs and German marks by exchanging cash flows with International Business Machines Corp. in 1981, hasn’t protected the institution from widening borrowing spreads.

Average yields relative to midswap rates on dollar- denominated supranational debt rose to 164.4 basis points, as of yesterday, from 46.8 basis points at the start of October, according to the Credit Suisse Liquid U.S. Corporate Sovereign Spread Over Swap index.

The midswap index, which contains bonds sold by the World Bank and the IADB, reached a record-high of 217.4 basis points on Jan. 2, Credit Suisse data show. A basis point is 0.01 percentage point.

A benchmark for borrowers, the midswap index lies between the bid and asking yields on contracts exchanging fixed for floating interest-rate cash flows.

Double Borrowings

The World Bank, whose projects now include financing AIDS prevention in Botswana and education reforms in Brazil, will more than double borrowings to as much as $35 billion this year to help provide food, health and education services through the International Bank for Reconstruction and Development, Richardson said.

Robert Zoellick, the bank’s president, recently announced plans for $100 billion of new loans over the next three years to relieve the recession. The lender issued $1.5 billion of five- year notes on Oct. 1 at 35 basis points below the midswap rate, a record low for that maturity, according to Richardson.

The International Monetary Fund, a Washington-based agency of the United Nations that monitors the global economy, may sell its first bonds to China and Brazil to raise money to combat the downturn. IADB borrowings will total $15 billion to $20 billion this year, up from $6 billion to $7 billion in 2007 and $11 billion in 2008, said Soren Elbech, the bank’s treasurer.

“There is a major crisis going on, and institutions like ourselves have been asked to step up to the plate and use our financial strength and pass it on to the regions that we cover,” Elbech said. “The IADB is heeding that call.”

Colombia’s Borrowing Costs

The benefit provided by development bank lending compared with borrowing private capital has increased as credit markets seized up, sending yields relative to Treasuries on emerging market debt to a six-year high.

Colombia, which received a four-year, $4 billion credit line from the World Bank last month, sold $1 billion of 10-year notes at 458.5 basis points above Treasuries April 14. That compares with 10-year notes Colombia sold in July 2006 at 229 basis points over Treasuries, Bloomberg data show.

Developing countries “are all in a position where they’re not going to welcome an increase in borrowing costs,” said John Williamson, a senior fellow at the Peterson Institute for International Economics in Washington. “But it’s not as bad as not getting the credit you need.”

While development lenders’ spreads more than tripled since October, the yield premiums on World Bank and other supranationals’ bonds have narrowed since their sale as corporate credit markets begin to heal.

Passed On

The three-year notes sold by the World Bank on March 26 rose to 100.4 cents on the dollar as of yesterday to yield 50.8 basis points more than Treasuries, according to Bloomberg data. That’s down from 82.2 basis points when they were issued.

Spreads on the IADB’s five-year notes sold April 13 fell to 109.8 basis points over Treasuries as of yesterday, from 140.25 basis points at their sale.

Increased financing costs are being passed to borrowers, according to Horst Seissinger, head of debt capital markets at Frankfurt-based KfW, which has a direct guarantee from the German government.

“What we are doing is what all the banks have to do,” he said. “The interest rates for the loans we grant to our customers have to reflect the re-pricing we have seen in capital markets over the last few months.”

Nathalie Druecke, a spokeswoman for the bank, said she couldn’t specify which projects are paying more because of the cost increase.

Energy-Efficiency Projects

KfW’s increased borrowing costs aren’t reflected “on a one to one basis,” in its lending, she said.

Development lenders face higher costs than the AAA-rated World Bank. IADB, which last month said it’s supporting $2 billion in Latin American and Caribbean energy-efficiency projects with the Export-Import Bank of Korea, paid 83 basis points more than the midswap rate on notes sold April 13 and due in 2014, according to Bloomberg data. That compares with 24 basis points below the benchmark on similar debt sold in February 2008.

KfW, a sovereign agency, sold $4 billion of notes due 2014 on March 3 priced to yield 162.8 basis points more than similar- maturity Treasuries, or 95 basis points over midswaps. The bank paid 83.5 basis points more than Treasuries, or 20 basis points less than the midswap rate on five-year debt sold in July, Bloomberg data show.

Supranational borrowers’ costs “went from the best of times to the worst of times within a matter of weeks,” said Daniel Shane, head of Morgan Stanley’s supranational and sovereign debt syndicate in London. “The problem with all this issuance materializing is that it completely cannibalized demand.”

Unlock Credit Markets

Banks began issuing government-backed debt on Oct. 22, when Barclays Plc of London sold 3 billion euros of three-year notes. The guarantees were intended to help unlock credit markets, which had been effectively shut since the bankruptcy of Lehman Brothers Holdings Inc. a month earlier.

New York-based Goldman Sachs opened the market for FDIC- backed debt on Nov. 25, issuing $5 billion of three-year notes. With top AAA rankings, they were priced to yield 200 basis points more than similar-maturity Treasuries, according to Bloomberg data.

Bank of America, based in Charlotte, North Carolina, is the biggest user of the FDIC program, raising $41.7 billion of dollar-denominated debt since Dec. 1, Bloomberg data show.

Michael DuVally, a spokesman for Goldman Sachs, and Scott Silvestri, a Bank of America spokesman, each declined to comment.

Temporary Program

“Credit market conditions have improved in response to government stabilization efforts such as the TLGP,” Andrew Gray, an FDIC spokesman, wrote in an e-mailed statement.

“The FDIC has taken steps to reduce reliance on this program, including establishing the deadline of Oct. 31, 2009 for any new issuances,” Gray wrote. “Clearly this is not a program that will exist in perpetuity.”

Worldwide losses tied to distressed loans and securitized assets may reach $4.1 trillion by the end of 2010, prompting private banks to further curtail lending, the International Monetary Fund said in an April report.

The IADB, which may approve a record $12 billion of loans to finance projects and enhance social programs in 2009, has raised lending rates, Elbech said. He wouldn’t elaborate.

Borrowers from the World Bank are still paying about the London interbank offered rate, the same as a year ago, according to Richardson. The institution’s cost of new debt hasn’t yet affected the overall average yield on existing bonds, Richardson said.

Libor is the rate banks say they charge each other for loans. It was set at 1.02 percent yesterday for three-month credit.

“If we’re going to be issuing at these wider, above-Libor spreads for a while, then you’ll see that lending rate move slowly higher,” he said.