Winners take all

IFR FIG 2010
10 min read

For the larger and more reputable banks, the senior unsecured market has been welcoming this year, and, at the top table at least, the financial sector looks to have put the worst of its troubles behind it. But cost remains prohibitive for smaller banks and those perceived to be higher risk, as the market becomes increasingly stratified. Hardeep Dhillon reports.

Financial institutions issued over €110bn and €23bn of guaranteed senior unsecured bank debt in Europe by the first week of September. Full-year supply is on course to reach forecasts of €150bn in senior bank debt, with possibly €45bn of guaranteed bonds, according to Societe Generale Corporate and Investment Banking.

Issuance in January alone accounted for €32.8bn in senior bank debt, and €9.3bn of guaranteed notes. By the end of April it totalled €72.7bn non-guaranteed and €23bn guaranteed bonds, according to SG CIB. Despite scant supply in May, renewed activity in the new issue market since June added another €38.05bn of new bonds by September 7. July issuance totalled €18.6bn.

Double A rated national champion issuers represent the bulk of issuance and largely have been able to access the primary market throughout the year, subject to price considerations. Borrowers tapping the market include banks from northern Europe and Scandinavia, France, Germany, the UK, stronger institutions in southern Europe, as well as the US, Canada and Australia.

Geographically, issuance has come from a diverse group which investors have viewed as positive. The supply profile is not expected to radically change for the remainder of the year, said Mark Geller, head of financial institutions syndicate at Barclays Capital. Issuance will continue to be mainly concentrated with the large Double A banks, he predicted. “If the market is at all receptive, then September and October could be extremely busy months.”

Unappealing for some

Some banks feel no real obligation to issue. They are reluctant to lock in funding at unfavourable pricing for long duration, given that spreads are still at comparatively wide levels historically. “Many high quality banks are not under pressure to issue debt at any level but would issue opportunistically,” said Alexander Plenk, deputy head of financials credit research at UniCredit.

Financial institutions generally seem to be in a fairly comfortable position, said Andy Sweeney, director, financials institutions syndication at RBC Capital Markets. “Most banks are currently well funded at the short end of the curve and well up on, if not fairly well ahead of, their annual funding targets.”

Some issuers could consider keeping open the option for a rainy day trade in the event they need a top up of liquidity going into year end. “Certain banks may later on recognise they require funding and decide to issue at relatively low execution risk and relatively low price,” said Anthony Tobin, director of EMEA syndicate at Bank of America Merrill Lynch.

Pre-funding in the fourth quarter of 2010 could be a theme for banks hoping to avoid a glut of supply in the first quarter of 2011. “Some issuers may choose to get runs on the board during this year due to current low yields and the huge volume of senior secured redemptions next year,” Tobin said.

Those borrowers with the luxury or capacity to pre-fund seem to be in an advantageous position. “Banks under less pressure are able to be strategically opportunistic and more tactical in placement, which could result in more orderly supply patterns,” said Julia Hoggett, head of financial institutions group flow financing for EMEA at BAML.

Banks’ financing plans to pre-fund for 2011 will be sensitive to movements in spreads, which will naturally widen if many deals are launched simultaneously, said RBC Capital Markets’ Sweeney. “That is a potential concern for Treasurers but as long as investor demand remains strong and there are no serious shocks there is no reason why the market should not proceed in a healthy fashion,” he said.

However, the primary market is yet to open up materially for weaker perceived financial institution borrowers. “Generally speaking, the higher the quality of the bank the lower the funding problem, the lower the quality the larger the problem,” said UniCredit’s Plenk.

It is still very expensive for many financial institutions to issue senior unsecured debt, said BarCap’s Geller. “Risk appetite needs to increase before some credits lower down the ratings spectrum are able to fully access the market on reasonable terms.”

Who can and cannot issue is constantly changing. The stress tests at the end of July and a more constructive market tone has helped boost client demand for a much broader range of financial institutions than several months ago.

“That does not mean that issuers from non-core Europe or non-national champion institutions are necessarily going to find it plain sailing,” said BAML’s Hoggett. “The continued use of other liquidity alternatives may still be necessary for some regions.”

ECB intervention

One recent measure that will help support vulnerable European banks in the short term is the decision by the European Central Bank to extend the full allotment procedures of its weekly, monthly and quarterly refinancing operations, at least until January 18 2011. This has alleviated the pressure for many weaker banks to issue senior unsecured bonds. “The low quality banks still have the possibility to fund via the ECB and do not have to rely on the capital markets which could dampen issuance volumes,” said Plenk.

The ECB extension and postponement of Basel II’s proposal for stable long-term funding to January 2018 will have a negative impact on the government guaranteed (GG) market, said Mauricio Noe, head of senior and covered bonds at Deutsche Bank. “I do not think many institutions will resort to the GG market, they are no longer desperate to fund at un-economic spreads,” he said.

Only €1.4bn of guaranteed senior paper has been issued since April and that was in one month alone: June.

A select group of names from different jurisdictions still rely on the GG market, though fewer financial institutions are accessing it for funding this year, said Hoggett. “The potential to fund on your own recognisance by moving away from the GG market is a very powerful message, and a rite of passage that many institutions have needed to go through,” she said.

Sweeney at RBC Capital Markets also foresees the continuation of GG market’s diminishing role, though a double dip recession and renewed credit concerns could see it return. “If the market deteriorates then governments can re-implement the GG market fairly quickly and easily, perhaps on an ad-hoc basis for individual issuances or up to a certain maturity,” he said.

In contrast to Europe, North American banks have not issued senior unsecured in volume this year. Canadian banks have very small funding requirements compared to their offshore counterparts and focussed greater attention on the US covered bond market earlier this year, said Sweeney. US banks are under-represented in new issuance compared to historically, which is explained by comparatively wide spread levels, added Mike Reiner, US credit strategist at SG CIB.

Bank 10-year bonds traded in the 235bp area over US treasuries in late August, compared to a low in the 200bp area earlier in the year prior to April’s Goldman Sachs investigation. “Banks are looking to be opportunistic and for a more attractive entry point,” he said. “However, with the potential for spreads to leak wider by yearend, more institutions may decide to lock in funding at ultra low yields.”

More European banks have targeted the dollar market and issued Yankee bonds in 2010 than in any year since 2000. This is mainly due to attractive funding rates in dollars versus other currencies and a favourable basis swap for swapping the bond proceeds back in euros.

RBS launched its largest ever US dollar unguaranteed senior bond, a US$3.6bn deal, while Banca Intesa, Credit Suisse, ING and UBS, in addition to Australian borrowers ANZ and Macquarie, all tapped the market in August. “The major accounts in the US have regained their appetite for European assets and the Yankee market is undoubtedly strengthening its capacity to absorb transactions,” said BAML’s Hoggett.

Deutsche Bank is looking to add to Yankee issuance flows in the coming weeks with sizeable trades for a number of European banks, not only in senior unsecured format, but also covered bond and lower tier two debt, said Noe. “The dollar market is front and central to banks’ plans, as it is able to offer the whole product mix as well as the funding size that the euro market offers, but at cheaper levels,” he said. “Certain banks no longer have to be entirely reliant on the euro and this will create price tension between their bonds.”

Banks have also issued in Swiss franc, Japanese yen and Australian and Canadian dollars, which are also expected to remain attractive markets to tap. “There has been more issuance in these markets than anticipated and banks will continue to issue opportunistically if there is exceptionally good value or a decent arbitrage in one market over another,” said RBC Capital Markets’ Sweeney. “It has become an ongoing theme over the last two years that diversification of funding is key for banks and this is going to continue.”

Investors seem to be more prepared to move down the credit curve in search of yield, which is a positive development for lower rated banks in their attempts to access the market, said Noe. “Seeing banks further down the credit curve start issuing is a really strong signal. It shows that investors are prepared to immerse themselves more meaningfully into the market to buy bank paper and chase yield,” he said.

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