Banks face US$340bn state-backed bond refi hole

Banks will struggle to refinance the upcoming mountain of government-guaranteed debt that is due to mature in the next two years unless the primary market fully thaws in the coming weeks, according to bankers and investors. Banks had planned to aggressively use the autumn period to get ahead of large refinancing requirements in 2012. Thomson Reuters data show that the US$230bn equivalent of European bank government-guaranteed debt will mature in 2012 and US banks will have more than US$122bn maturing.

Governments started guaranteeing banks’ debt issuance in September 2008 as capital and money markets froze after the failure of Lehman Brothers on September 15th.

Most of the guarantees had a three-year maturity, although Spain and France allowed banks to issue up to five years.

“The wall of upcoming maturing government-guaranteed debt is a concern, especially if the current market freeze goes on for much longer and spills over into 2012,” said Martin Lukac, financials credit analyst at Principal Global Investors.

“If you look back, the government-guaranteed schemes were all established around the same time and were limited in terms of maturities which means that a lot of them are coming up at the same time, making the banks’ maturity profile very frontloaded,” said Lukac.

Pressure has built up in the financial sector. In recent weeks, fears that the euro zone sovereign debt crisis will spill over into banks has seen U.S. money market funds start to rein back the maturities they are willing to lend to them.

“Bank treasurers know that next year is a big year for government-guaranteed refinancing and part of the reason why some of the larger funders in the market did so much at the beginning of this year was because a lot of them wanted to pre-fund some of next year’s maturities in the autumn,” Robert Kendrick, financials credit analyst at L&G.

“This was to mitigate a concentrated refinancing burden over the next couple of years, brought on by most government-guaranteed issuance being limited to 2012 or 2013, rather than being more evenly spread,” said David Loughran, debt syndicate at Lloyds Capital Markets.

The two biggest bank funding avenues, senior debt and covered bond issuance, have been largely shut since early July.

“The problem is, issuance has now ground to a halt, and even if they were ahead at the end of June, they might now struggle to complete this year’s funding,” said Kendrick.

Market shutdown

According to Thomson Reuters data, a mere US$7bn equivalent of senior was raised by European banks in July while the tally for August is even lower at just over US$1bn equivalent. This compounded poor volumes in June when US$17.4bn was sold, well below May’ s figure at US$41.2bn.    

It’s a similar story for the normally resilient covered bond sector, where ING Bank’s announcement on Wednesday that it was planning a 10-year euro offering was the first benchmark launched since early July when €8.1bn was raised. So far, the tally for the whole of August is a mere €1.2bn.

Financial indices have performed very poorly in recent weeks, according to Markit, its Senior Financial index hit a record wide of 260bp on Tuesday.

It is not just a matter of the large refinancing size that will be a challenge. Another will be finding investors in bank debt.   

“A problem that bank treasuries have been working to avoid is a number of the people who bought government-guaranteed debt won’t buy anything else,” said Lloyds’s Loughran.

“So it’s not as if the market will get a liquidity event and have cash to put to work in bank paper. For some of these investors, even a Triple A RMBS or covered bond won’t necessarily float their boat.”

Banks’ pursuit of new investors will be hindered by fears of haircuts on senior debt: the debate on senior bondholder bail-in will return in the autumn when the European Commission releases its legislative framework on banks’ resolution and recovery.

Meanwhile, investors are likely to demand higher premiums in order to protect from volatility as good new issue performance is not guaranteed given the market backdrop and the lack of solution to the European sovereign crisis.

“If we were to see a new issue from a bank, the issuer would have to offer a substantial new issue premium,” said Lukac. “We would also expect demand for new deals to be diminished given that US-based accounts are currently not adding European risk and this can really be felt in the market.”

L&G’s Kendrick added that said that while some of the current concerns in the market were somewhat unjustified, he would be reluctant to put cash to work right now.

“Selling a senior deal is very hard right now and in order to buy, we would need to have confidence that a deal will perform and not be 50bp wider the following week,” he said.

While the refinancing numbers drop off dramatically in 2013 and 2014, European banks’ still have US$41bn and more than US$94bn coming up to maturity in 2013 and 2014. Furthermore, as much as US$63.8bn of European government-guaranteed bank debt is maturing before year-end and US$49.5bn for US banks.