Eye of the beholder
As summer drew to a close, European banks enjoyed a considerably smoother path to investors than seemed likely only a few weeks before. But whether the improvement in funding conditions will endure is debatable. Simon Boughey reports.
At first glance, the progress made by a core group of financial institutions since the release of the European banks stress tests on July 23 was impressive. The following week saw BBVA become the first Spanish bank to issue unsecured senior debt since April, when it sold a €1.25bn five-year note. The price at which it sold the notes – mid-swaps plus 170bp – was also 30bp inside where an array of syndicate sources had thought it likely to print.
“The market has improved hugely from the conditions seen during April and May, although we have a little way to go to reach the kind of backdrop we saw in Q1,” said Mark Geller, head of financial institutions syndicate at Barclays Capital in London. “The results of the stress tests and recent earnings numbers have improved confidence significantly and we have seen a strong rally in senior bank spreads.”
There are various reasons why the mood has ameliorated so much from the spring. Top of the list, according to most London syndicate bankers, is the stress tests. Although this examination of the European banking system was far from flawless, it did bring some much-needed clarity to the situation.
The generally good half-yearly results recorded by the banks are another factor, while growth rates in some European countries have been better than expected. The austerity measures introduced by the new UK government have won widespread plaudits from the capital markets.
One of the success stories for European banks in the last few weeks of the summer was the Yankee market. UBS got the ball rolling with a US$2.5bn 10-year at the end of July, and then on a single day – August 10 – HSBC, ING and Royal Bank of Scotland raised a total of US$5.6bn.
“A lot of the more frequent borrowers have done more than 50% of the funding required for 2010. The dollar market is looking good at the moment, as proved by the success of HSBC, RBS and ING,” said Edward Stevenson, head of UK and North European FIG origination at BNP Paribas in London.
The Yankee market offers a series of signal virtues for the European bank borrower. It presents investor diversification, the chance to issue in size and at longer maturities than in euros and a hefty basis swap pick-up to euros.
But to derive benefit from the US market required a considerable shift in sentiment from American investors. In the spring, US buyers were reluctant to touch anything made in Europe. By August real money accounts were falling over themselves to get their hands on European bank paper.
London bankers were quick to attribute the Yankee success to the stress tests. Many bankers in New York saw it differently. “The ECB had a much more meaningful impact on the market’s willingness to fund the banks than the stress tests. The market had been worried about the banks and sovereigns defaulting. When the ECB - in combination with the EU - stepped up, it eliminated the risk of anyone defaulting,” said Justin D’Ercole, head of Americas investment grade syndicate at Barclays Capital in New York.
Fast money accounts which had been gambling on at least one or two European bankruptcies also had to think again. “The hedge funds had bet on liquidity events. They did it with Lehman and they got it right. They did so with Morgan Stanley, Goldman Sachs, Citi, but the Fed bailed them out. Then they tried to bet on liquidity events in Europe but the ECB stopped them,” said a US syndicate banker.
The haves and the have nots
All this explains why some banks are now able to borrow in senior format. But there are still many banks that cannot do so – or can only do so at prices that would be economically unsound. As a result of the sovereign debt crisis, a distinct ‘tiering’ process has occurred within the European banking universe.
“There is still a proportion of banks that are facing the same issues that they did three months ago – that is to say that their access to the wholesale funding market on an unsecured basis remains challenging. There are haves and have nots,” said Marc Tempelman, head of EMEA financial institutions at Bank of America Merrill Lynch in London.
In the latter category are banks from Ireland and those from Mediterranean countries that are not national champions. Santander and BBVA clearly can, as shown by recent business, but other Spanish institutions, particularly a whole range of cajas, would find the price that the senior market demands unacceptable. Banco Sabadell would not fare well, said a head of European FIG syndicate.
The jury is still out on the Portuguese banks as the sovereign has yet to fund. But lots of German local banks, including WestLB, would struggle, said bankers in London, while BPCE would also be received frostily. And nobody is touching Greek bank paper.
Meanwhile, the Irish banks – particularly Bank of Ireland – are damaged by being Irish, despite being in fundamentally good shape. “The Irish banks suffer from the link to the sovereign at the moment,” said Vinod Vasan, head of European FIG DCM at Deutsche Bank in London. “Bank of Ireland has done its capital raisings and is actually well capitalised.”
Moreover, Ireland is not in such a bad state as some might imagine. According to sources close to the Irish treasury, the sovereign has to refinance €16bn of debt over 2010-2013, which represents 10% of GDP. Greece has to find €90bn in the same period, representing 38% of GDP.
Nonetheless, Bank of Ireland trades at mid-swaps plus 400bp in the secondary market, so a new issue would need to be priced at around mid-swaps plus 425bp to provide a sufficiently alluring premium to old debt. This would make liabilities more costly than assets. “Many European banks could issue senior unsecured but the price they would have to pay would undermine their business model,” said Vasan.
There is also no guarantee that having printed one deal at plus 425bp, Bank of Ireland would be able to come back and do a second or a third at the same price.
Allied Irish is much wider at plus 500bp, most Portuguese banks are in the plus 400bp range and a lot of Spanish banks are at plus 300bp. Some will probably choose to issue just to prove that they can come to the market, but they cannot do this on a long-term basis.
Reputation is king
What deters investors is not that these banks will collapse, but that spreads could widen dramatically due to a sudden resurgence of sovereign risk, or renewed jurisdictional risk. Consequently, banks not in the magic circle must fall back on the source of debt that has served them well for the last two years – secured funding, in particular the government guaranteed debt programmes and covered bonds.
“Those that still face problems will turn to the government guaranteed bond market. In most cases, there is a price for everything. The Irish banks will have access under the GGB programme and some will be able to access the covered bond market as well,” said Stevenson.
But the sceptics are not convinced that these two routes will provide a satisfactory answer either. For those banks in jurisdictions that are less than wholly reliable, the guarantee furnished by the sovereign might not appear particularly reassuring.
“How much is the government guarantee worth if it’s Irish or Portuguese? Banks love to lend to people who are solvent but there is a reluctance to lend to people in jurisdictions that are suspect. Does the Irish guarantee add much?” asked a senior FIG banker in London.
At the same time, covered bonds that have been priced so far this year have chiefly emanated from banks in more secure jurisdictions. While a Portuguese bank selling a covered bond backed by German mortgages might be able to fund at an economic level, there is more doubt that an Irish bank backed by Irish mortgages would be able to do so. (For more, see covered bonds article.)
Some banks may thus still be in a deep hole. “If you can’t do government-guaranteed funding because of the jurisdiction you are based in, if you can’t do covered bonds and if you can’t do unsecured because of your credit rating, you’re running out of options,” said Tempelman.
In fact, it leaves only one option – the ECB, the final solution to the often intractable problems some European banks face. Around €587bn was lent under the repo programme in August 2010 excluding the covered bond scheme, and while this is less than in the previous few months it is still a large sum. In July, €632bn was advanced and between April and June it was never less than Eu729bn, rising to €817bn in June. Average monthly volume in 2006 was €429bn.
The ECB has proved that it is unprepared to let a European bank go to the wall and will expend countless euros in defending the Eurozone project. The so-called second tier European banks must hope that this commitment and largesse continues to be inexhaustible.