Federal Agencies and Supranationals

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Federal Agencies and Supranationals

March 20, 2019

Dan Krieter, CFA

[email protected]

312-845-4015

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Agency Debt Declining With FN/FR in Conservatorship

• State and local agency holdings have fallen as FNMA and FHLMC have shrunk debt outstanding.

• What should managers do with the portion of the portfolio traditionally held in agencies?

• Stay in agencies?

• Migrate to SSA?

• Both?

Source: FNMA, FHLMC, FHLB, FFCB, FRBNY

Fixed Income Strategy

State and Local Agency Holdings ($ bn) Outstanding Non-DN Agency Debt ($ tn)

2

SSA: A Brief Overview


• SSA:

• (Sub) Sovereign – National or

sub-national

• Supranational – International

organization whose mandate

extends across national

boundaries

• Agency – Government

sponsored corporation that

typically functions for a social or

public need

• BMO’s SSA Cheat Sheet is a good

resource for an overview of each

entity’s business and key information

Source: IFC Investor Presentation

Key Supranational Statistics

IFC IBRD IADB ADB AfDB EBRD EIBInternational

Finance

Corporation

International Bank for

Reconstruction and

Development

Inter-American

Development

Bank

Asian

Development

Bank

African

Development

Bank

European Bank for

Reconstruction

and Development

European

Investment

Bank

Business

Lends and

invests equity

in private

enterprises in

developing

countries

Provides loans to

public sector in

developing countries

Development

bank for Latin

American and

Caribbean

economies

Fosters

economic

development

and

cooperation

in the Asia

Pacific region

Invests and

lends to

development

projects in

Africa

Development

bank which leands

to Eastern and

Central European

economies

Help

finance

balanced

economic

developme

nt in EU

states

Ownership184 member

countries

189 member

countries

48 member

countries,

consisting of

Latin America

and OECD

countries

67 member

countries, of

which 23 are

OECD

countries

holding 64.6%

of total

54 African

member

countries and

25 non-African

member

countries

66 members - 64

countries, the EU

and the EIB

28 member

states of the

EU

Total Assets ($ bn) $94 $403 $126 $182 $46 $67 $659

Liquidity Liquid Assets/Total Assets 41% 18% 26% 20% 39% 44% 13%

Leverage Total Liabilit ies/Total Liabilit ies +

Shareholder's Equity (excluding callable capital)72% 90% 74% 72% 78% 71% 87%

Total Shareholders Equity $26 $42 $32 $50 $10 $19 $83

Paid-in capital as % of total capital 100% 6% 7% 5% 7% 21% 9%

Net income before Transfers ($ mn) $1,360 $876 $615 $774 $358 $892 $3,240

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SAFETY: Agencies Have Very Strong Balance Sheets and a Strong Implicit Guarantee


• Agency Credit Quality:

• Strong balance sheets. FHLB has never had a credit loss on its

advance portfolio in its history given collateral backing loans.

• FNMA/FHLMC mortgage portfolios are much stronger following

increased underwriting standards after the crisis.

• FFCB has a strong asset portfolio, with nonaccrual loans at less 1% ot

total. Some loans are also collateralized.

• Implicit guarantee from the United States government, which would

likely be used were it ever necessary (FNMA/FHLMC).

Single Family Delinquency Rate (%)

Source: FNMA, FHLMC, FHLB, FFCB

FFCB Nonaccrual Loans (% of Total Loans)

FHLB Credit Exposure and Collateral ($ bn)

0.69%

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SAFETY: Supranationals Offer the Safety of Multiple Governments


• Supranational Credit Quality:

• Backed by paid-in and callable capital from member countries.

• Callable capital sufficient to cover outstanding debt even assuming 100% default rates on their loan

portfolios.

• Have never had to make a claim on callable capital.

• Preferred creditor status.

World Bank Loans and Available Capital

Source: IBRD/IADB Investor Presentation

IADB Loans and Available Capital ($ bn); IADB Callable

Capital = $164.9 bn

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SAFETY: Washington Supranationals Offer an Additional Degree of Security


• The United States is the largest shareholder of each of the supranationals, representing at least

15% of each, and each is headquartered in Washington DC.

• Structural changes to the supranationals require an 85% supermajority, therefore the United States

is the only country that retains the power to veto structural changes at IBRD, IFC and IADB.

Source: IBRD/IADB/IFC Investor Presentation

Member Countries with the Highest Share of Voting Power

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SAFETY: Strong Credit Quality Makes Agencies and SSAs “Flight to Quality” Assets


Source: BMO CM, Bloomberg

5yr Corporate CDS and Agency/SSA Yields 2008 Total Return (%)

• Inverse correlation between agency/supra yields and corporate credit default swap rates

• Both agencies and supranationals had positive total returns in 2008 during the peak of the financial

crisis, while corporates were negative and stocks were sharply negative.

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• Liquidity is stronger in the agency market with a bid/ask spread consistently below 2bp.

• Supranational liquidity improving as more market participants become familiar with the market.

• SSA bid/ask spreads similar to agencies in normal times, but still vulnerable to drops in stressed market

environments, such as the experience during Brexit in mid 2016.

• Corporate bid/ask typically around 10bp

Source: TradeWeb, , Bloomberg, BMO Capital Markets

Fixed Income Strategy LIQUIDITY: Bid/Ask is One Often Used Measure of Liquidity…

Bid/Ask Spread (bp)

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• According to TRACE statistics, approximately $3.75 bn of agency securities trade each day, down from

~$6bn per day in 2013, and well below corp/MBS markets.

• However, when comparing trading volume to market size, 0.03% of the non-DN agency market trades

each day, on par with corporates and MBS.

• Unfortunately, supranationals are exempt from TRACE reporting. How can we compare liquidity?


Fixed Income Strategy LIQUIDITY: …Another is Market Depth

Monthly Trading Volume/Market Size (%) Average Daily Trading Volume ($ bn)

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• Market Efficiency Coefficient (MEC) is a measure of liquidity that essentially focuses on how orderly

price movements incorporate new information.

• As expected, Treasuries are first and agencies are second. Supranationals trade with liquidity more

like agencies than like corporates.


Fixed Income Strategy LIQUIDITY: MEC Can Also Be Helpful in the Absence of TRACE Statistics

MEC Between 2013 and 2018

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RETURN: Impressive Credit/Liquidity with a Spread to Treasuries

Agency Spread to Treasuries


Source: TradeWeb, BMO Capital Markets

Supranational Spread to Agencies

Supranational Spread to Treasuries

• Agency/supranational spreads to Treasuries

tighter than the average over the past five years.

• Supranational spreads are wider than agencies

at the short end, but narrower at the long end.

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Name Diversification

• FHLB/FFCB now account for most GSE

issuance, and could run up against name limits

• The USD SSA market has grown to 100% of the

non-DN US agency market, compared to 23% in

2008.

Source: FNMA, FHLMC, FHLB, FFCB, Bloomberg


USD Non-DN Debt Outstanding ($ bn)

2017-18 Net Agency Issuance ($ bn)

Agency Non-DN and SSA Debt Outstanding ($ bn)

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Diversification of Product Type

Source: FNMA, FHLMC, FHLB, FFCB, Bloomberg


• While gross issuance in the agency market remains far

larger than SSAs, SSAs issue more benchmarks than

agencies.

• 82% of USD SSA gross issuance comes from

benchmarks, compared to just 6% for agencies.

• Agencies and SSAs both offer all product types, but

diversifying allows investors to target certain product

types more easily.

• SSAs->bullets, large deals.

• Agencies-> Structured products, floaters

Gross SSA Issuance ($ bn)

Gross Agency Issuance ($ bn)

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Fixed Income Strategy Diversification of Buyer Base

Distribution of Post-Crisis New Issue SSA Deals (%) Distribution of 2018 FNMA Benchmark Deals by Type (%)

Source: BMO CM, Informa, FNMA

Distribution of 2018 FNMA Benchmark Deals by Location(%) Distribution of 2018 SSA Benchmark Deals by Location(%)

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LCR helps explain why banks are so much more active in the supranational market

Source: BMO, Basel Committee

• Every dollar used to hold HQLA is one that cannot be used to

invest in higher returning investments

• Therefore, the haircut taken on Level 2A and Level 2B

securities in the LCR is very important

• SSA debt returns more than any other Level 1 eligible asset

class except GNMA MBS

LCR Haircuts

Level 1 0%

Level 2A 15%

Level 2B 50%


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Fixed Income Strategy Diversification of Funding Cycle

• Supranationals fund according to an annual

borrowing requirement, with heavy seasonality to

issuance patterns.

• Agencies are needs-based funders, heavily

dependent on redemptions to dictate when

funding is required.

• Differing funding drivers mean supply likely to be

there from one or the other most of the time.

Agency Bullet/Callable Redemptions ($ bn) Average Post Crisis Monthly Gross Non-DN Issuance ($ bn)

Source: BMO CM, FNMA, FHLMC, FHLB, FFCB

Average Post-Crisis % of Annual SSA Issuance(%)

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Diversification of Risk Exposure

SSA Credit Risk Factors Agency Credit Risk Factors

• Credit rating dependent on capital of

countries all around the world.

• Exposed to European risk

• Exposed to emerging market stress.

• Exposed to isolationist risk.

• Insulated from deficit/US downgrade risk.

• Insulated from GSE reform risk.

• Insulated from US housing market risk.

• Credit rating dependent on US rating.

• Insulated from European risk.

• Insulated from emerging market stress.

• Insulated from isolationist risk.

• Exposed to deficit/US downgrade risk.

• Exposed to GSE reform risk.

• Exposed to US housing market risk.


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• SSA borrowers were the very first issuers in the

sustainable bond market and remain important

borrowers today.

• SSA institutions are experts in the sustainable bond

space, with frameworks and reporting standards

greatly exceeding the standards of other borrowers

and continue to evolve the sustainable bond market.

• The agencies have accounted for 77% of all SOFR-

linked issuance to date, and expect to remain the

largest SOFR-linked issuing sector in the world.

• Once again, both sectors are active in both markets,

but each has a specialty in differing markets.

Source: Bloomberg, Climate Bonds Initiative, BMO Capital Markets

Fixed Income Strategy Agencies/Supras are Leaders in Growing Fixed Income Markets

Green Bond Issuance ($ bn)

SOFR-Linked FRN Issuance by Type (%)

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Source: Bloomberg, TradeWeb, BMO Capital Markets

Fixed Income Strategy Market Overview: Narrow Swap Spreads to Blame for Tight Credit Spreads

3yr Spread to Treasuries (bp) Swap Spreads (bp)

• A significant narrowing of swap spreads over the past six weeks has driven agency/supranational

spreads to the narrow end of multiyear trading ranges

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vs. Swaps

Last 1wk Chg 1m Chg 3m Chg 3m Avg 6m Avg 12m Avg 3m Z Score 6m Z Score 12m Z Score

11.7 11.8 -0.3 0.7 0.710 13.4 -0.2 -0.8 0.8 13.8

8.8 9.5 -0.2 0.8 0.57 10.8 0.4 0.4 3.2 11.1

2.5 2.3 -0.9 0.5 0.65 4.3 -1.5 -1.6 4.5 6.0

-1.7 -3.3 -1.0 0.3 0.83 -0.9 -1.0 -2.4 2.3 1.1

-3.8 -6.3 -0.5 0.3 0.82 -3.3 -1.0 0.5 -0.1 -2.4


Fixed Income Strategy Market Overview: Attractive ASW Valuations May Provide More Support for Supranationals

Agency Spreads Supranational Spreads

vs. TSY


16.8 16.8 -1.3 -1.0 -1.110 15.6 -0.6 -2.2 -2.4 17.2

15.4 16.0 -0.9 -0.9 -1.37 13.9 0.4 -0.9 -2.3 15.8

14.4 15.8 -1.6 -1.2 -1.35 12.8 -0.7 -2.3 -1.0 15.1

12.8 14.8 -2.1 -2.3 -1.93 9.7 1.9 -3.5 -2.3 12.7

13.5 15.6 -1.0 -1.4 -1.52 10.2 -0.4 -0.8 -5.7 12.4

vs. TSY


33.7 30.6 -1.7 -0.2 0.310 32.6 -2.0 -7.7 -1.8 38.6

18.6 18.3 -0.9 0.4 0.47 20.0 1.0 -4.0 1.7 21.9

9.9 10.4 -0.9 -0.9 -1.05 8.7 0.8 -1.0 -3.4 9.8

5.6 5.7 -1.1 -0.5 -0.43 5.0 -0.4 -2.5 -0.8 6.3

6.2 6.8 -0.5 -0.3 -0.52 5.5 1.1 0.4 -4.6 6.5

vs. Swaps


28.7 25.4 -1.3 0.2 0.810 30.5 -1.7 -6.7 0.9 35.4

12.5 11.2 -0.5 0.7 1.17 16.2 0.5 -2.9 4.9 17.6

-1.8 -3.5 -0.5 0.6 1.15 0.2 0.0 0.0 2.0 1.0

-8.9 -12.7 -0.2 0.8 1.33 -5.7 -1.0 -1.4 3.6 -5.3

-10.9 -15.0 0.1 0.9 1.32 -8.1 0.5 1.8 0.1 -8.2

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Fixed Income Strategy Market Specific Discussion: Agencies

• Relative value favors agencies as the

spread give up for other traditionally

higher spread sectors is low compared

to trading ranges over the past year

• However, agency spreads to Treasuries

are rich on an absolute basis,

particularly in the short end

2yr Intersector Spreads (bp)

2yr vs. Swaps US Agency Washington Supra Euro Supra Euro Agency CAD Provie Covered

US Agency -- 6.0 7.3 11.3 22.0 35.2

Washington Supra -6.0 -- 1.4 5.3 16.0 29.3

Euro Supra -7.3 -1.4 -- 3.9 14.6 27.9

Euro Agency -11.3 -5.3 -3.9 -- 10.7 24.0

CAD Provie -22.0 -16.0 -14.6 -10.7 -- 13.3

Covered -35.2 -29.3 -27.9 -24.0 -13.3 --


US Agency -- -1.2 -1.2 -1.5 -1.6 -0.6

Washington Supra 1.2 -- 0.0 -1.4 -0.5 0.1

Euro Supra 1.2 0.0 -- -1.5 -0.6 0.1

Euro Agency 1.5 1.4 1.5 -- 0.7 1.0

CAD Provie 1.6 0.5 0.6 -0.7 -- 0.5

Covered 0.6 -0.1 -0.1 -1.0 -0.5 --



US Agency -- 5.0 4.3 12.7 25.4 35.8

Washington Supra -5.0 -- -0.7 7.7 20.4 30.8

Euro Supra -4.3 0.7 -- 8.4 21.1 31.5

Euro Agency -12.7 -7.7 -8.4 -- 12.7 23.1

CAD Provie -25.4 -20.4 -21.1 -12.7 -- 10.4

Covered -35.8 -30.8 -31.5 -23.1 -10.4 --


US Agency -- -1.7 -2.3 -2.7 -1.7 -1.9

Washington Supra 1.7 -- -2.2 -1.6 -0.8 -0.7

Euro Supra 2.3 2.2 -- -0.4 0.5 0.3

Euro Agency 2.7 1.6 0.4 -- 0.6 0.5

CAD Provie 1.7 0.8 -0.5 -0.6 -- 0.0

Covered 1.9 0.7 -0.3 -0.5 0.0 --



US Agency -- 3.9 4.4 15.1 34.4 50.2

Washington Supra -3.9 -- 0.5 11.2 30.5 46.3

Euro Supra -4.4 -0.5 -- 10.7 30.0 45.8

Euro Agency -15.1 -11.2 -10.7 -- 19.3 35.1

CAD Provie -34.4 -30.5 -30.0 -19.3 -- 15.8

Covered -50.2 -46.3 -45.8 -35.1 -15.8 --


US Agency -- -0.8 -2.2 -0.8 -0.1 1.5

Washington Supra 0.8 -- -2.0 -0.5 0.7 1.6

Euro Supra 2.2 2.0 -- 1.3 1.8 2.0

Euro Agency 0.8 0.5 -1.3 -- 0.7 1.6

CAD Provie 0.1 -0.7 -1.8 -0.7 -- 1.8

Covered -1.5 -1.6 -2.0 -1.6 -1.8 --

vs. TSY


33.4 29.9 -0.4 0.5 1.010 36.2 -4.2 -6.3 5.8 38.0

18.7 18.0 0.1 0.8 1.07 21.8 -0.2 -2.1 5.8 21.4

9.9 10.6 -0.2 0.2 -0.35 10.1 -0.1 0.2 -1.1 10.4

5.4 5.7 0.6 1.1 0.73 7.0 -0.6 -1.1 2.0 6.2

6.0 6.9 -1.4 -0.7 -1.02 4.4 -0.9 -0.9 -5.0 7.3

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Source: Bloomberg, FNMA, FHLMC, BMO Capital Markets


Gross Agency Issuance ($ bn)

• Gross agency issuance now dominated by floaters

(Money market reform/SOFR)

• Bullet and callable net issuance has been negative

for the majority of the decade

Net Agency Issuance ($ bn)

Retained MBS Portfolios and Cap ($ bn)

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10yr Agency Spread to TSY (bp)

• The Trump administration is expected to announce a plan for GSE reform in the near future

• The plan is expected to include Congress; Trump does not want to unilaterally reform the GSEs

• Expect the announcement to quickly follow the confirmation of Mark Calabria as the next Director of the

FHFA

Recent GSE Reform Events

Jan 6 – Mel Watt’s Term as FHFA Director Ends

Jan 18 – Acting Director Otting tells GSE employees a plan to end conservatorship expected “within weeks”

Jan 29 – White House spokesperson walks back Otting’s comments and says that the Trump administration expects to release a plan for Congressional GSE reform “shortly”

Feb 27 – Senate Banking Committee approves Mark Calabria as next FHFA Director

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Source: Bloomberg, YieldBook, BMO Capital Markets


Chart on Callable Issuance Swaption Volatility (bp)

• Callables perform well in environments where interest rates are range bound, and a compelling

argument could be made that we’re in such an environment

• However, volatility is near cycle lows once again. If/when volatility does increase, perhaps surrounding

Brexit, we favor callables

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Source: Bloomberg, BMO Capital Markets

Fixed Income Strategy Market Specific Discussion: Supranationals

• USD SSA market issuance has been extremely

light over the past year

• This is partly because of more attractive

funding costs in other currencies, but the SSAs

simply borrowing less is the primary driver

• Technicals likely to keep spreads low

Net USD SSA Issuance ($ bn)

Gross and Net USD SSA Issuance Through Feb ($ bn) Gross and Net SSA Issuance in all Currencies Through Feb ($ bn)

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Fixed Income Strategy Market Specific Discussion: Supranationals

3yr Spread to TSY (bp)

3yr IG Spread to Supra (bp)

• Relative value picture favors supranationals that most government portfolios have approved

• Getting additional SSAs on approved lists can pay off when spreads for tier 2 SSAs move wider

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Source: Bloomberg, Climate Bonds Initiative, BMO Capital Markets

Fixed Income Strategy In Conclusion

Supranationals Despite tight spreads, supranationals likely to receive some support from asset swappers and short end spreads are relatively attractive

Little compelling value further out the curve

Structured supranational debt can offer a modest pickup over agency structured notes, and are also attractive in the current market environment

Sustainable bonds present an opportunity for additional outperformance if overwhelming demand results in a premium

Work to add other SSAs to approved lists for further diversification and enhanced yield when spreads on tier 2 borrowers move wider

Agencies Watch for GSE reform headlines that have the potential to significantly impact GSE spreads

Long end agency bullets are a compelling play on reform headlines

Despite favorable relative value, short end bullet spreads offer little value at current levels and likely need some swap spread widening

Callables/structured notes make sense in the current market environment, and we like adding to these positions during transitory spikes in vol

Agency market a great way to add SOFR exposure

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Federal Agencies and Supranationals

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