Buysiders avoid SEFs with non-standard swaps

John Deere and Ally Financial were the only two US ABS issuers to print deals in a quiet week yielding just US$1.751bn, as the last hurrah of summer kept many bankers and investors away from their desks. Year-to-date ABS issuance rose to US$139.502bn, as of late Friday morning, according to IFR data. That put volume US$10bn ahead of the US$128.737bn tally SDC had for this time last year. Excluding self-funded issuance, US$125.382bn had priced as of late Friday morning versus US$115.993bn last year, according to SDC. John Deere’s US$1bn JDOT 2014-B trade via RBC (structuring), Citigroup and MUSI, which bundled new and used agricultural and construction equipment loans, had a better showing than Ally’s subprime auto loan deal. Its four Triple A classes priced mostly 1bp–2bp inside the issuer’s similar print in April, according to IFR data, with its longest 3.28-year A4 offering the most yield of its classes at a still-slim 1.512%. The tranche priced at interpolated Swaps plus 25bp, versus 27bp on a similar class from John Deer’s spring issuance. Overall US$8.9bn equipment loan and lease ABS deals have priced so far this year, according to IFR data. In the more volatile subprime auto loan sector, Ally Financial cleared the US$750m AFIN 2014-3 via Citigroup, Credit Agricole-CIB and JP Morgan. It was its third deal this year. The subprime auto ABS sector has come under sharp scrutiny of late. Both General Motors and Santander Consumer USA Holdings in early August acknowledged subpoenas from the Department of Justice about their securitisation underwriting platforms. This was the first subprime deal from Ally since those probes were revealed and sent riskier tranches in subprime auto wider. For its part, Ally CEO Chris Halmy said that despite sharp competition and “noise about loosening lending standards,” his firm had not shifted its risk appetite in the past two years, while speaking during the firm’s quarterly call in late July. Spreads on the Ally deal were mostly unchanged at the top, ending just 2bp wider on its Triple A rated US$255m A1 and US$166m A2 classes, versus the issuer’s previous deal in April. But the gap was a more bulky 20bps on its riskier US$32.71m A3/BBB rated D class, which printed at interpolated swaps plus 160bp. It retained the US$38.2m Aa1/AA rated Class B and US$36.19m Aa3/A rated Class C tranches. The issuer had previously offloaded those classes on all its deals over the past two years, according to IFR data. Two deals priced in the CLO market. Octagon Loan Funding Ltd printed via Greensledge Capital Markets. The US$413m deal for portfolio manager Octagon Credit Investors had a Class A1 tranche that printed at three-month Libor plus 145bp, down to the junior E class which priced at 520bp. And Atlas Senior Loan Fund VI, a US$564m issue managed by Crescent Capital Group LP, came with a Triple A rated Class A at Libor plus 154bp, down to the junior E class at 540bp via Deutsche Bank.

A real estate investment company part owned by National Bank of Greece and Invel Real Estate has put securitisation technology to use to provide some medium-term funding for the group. The privately placed, unrated Pangaea Funding 1 closed on August 22 through Cairn Capital, backed by rental payments on 77 properties predominantly let to National Bank of Greece. Greek banks have taken tentative steps back into the bond market in recent months, the last being Eurobank with a €500m trade in June, but in unsecured format. With this trade, NBG and Invel were able to apply leverage to a pool of real estate assets owned by their NBG Pangaea REIC entity, for which the ownership structure is split 34%/66% respectively between the bank and the real estate manager. They selected a group of assets valued at €473.6m as of May 2014, to back a €237.5m transaction. The LTV is low at around 50%, and there are also covenants written into the documentation to protect investors. For example, the LTV is capped at 75% and there is also a requirement to ensure that the quarterly rental to quarterly finance cost ratio is at least 1.5. Most of the properties are retail assets (51), followed by office with 25 and a single property described as other. By percentage of annualised passing rent, the retail pool contributes 56.9%, the office assets 41.9% and the remaining property 1.2%. As at March 31 2014, the portfolio was leased to 14 tenants under 99 mainly long-term lease agreements. The properties generate €43.8m of annualised passing rent, of which 99.5% in from leases due in 2038. Leases on 76 of the properties, signed in December 2013, are for a 25-year term and each NBG tenant has the right to renew its lease twice for five years each time. The notes backed by these payments were placed with a single account following a direct discussion with the investor keen to take on real estate exposure at an attractive yield. The deal printed at three-month Euribor plus 485bp, at a price of 98.91, which pushes the margin above 500bp for notes with an average life just short of five years. By comparison, Eurobank paid mid-swaps plus 386.5bp, or a yield of 4.375%, on its four-year deal two months ago. The benefit for NBG of doing a transaction in this format is that it can use assets that have previously been unleveraged, and a private trade removes execution risk of a publicly marketed trade. And with the investor happy to take unrated debt, it strips out the constraint of the sovereign cap too. This is the second CMBS managed by Cairn, following Debussy DTC in June 2013. That transaction, which was also the first non-bank arranged CMBS since the financial crisis, refinanced the loan granted to Toys R Us and securitised in Vanwall Finance. Invel announced at the start of the year that it bought the stake in Pangaea for about €653m, which included a €125m investment from York Capital Management. At the time, Invel said that Pangaea, the largest Greek REIC, aimed for a €1bn portfolio in the first quarter, rising to €2bn of assets over the next five years. NBG Pangaea REIC was formed in 2010. It owns and manages real estate assets of nearly all NBG’s main office buildings and its branches.

Tougher rules adopted last week for the US asset-backed securities market will give investors more transparency in public deals but private offerings remain untouched by the new reforms. The US Securities and Exchange Commission voted unanimously to approve the so-called “Regulation AB II” measures, which will supply buyers with a deeper dive into loan-level data on deals that package car loans, mortgages and consumer debt into bonds. For the first time ever, ABS issuers will need to hand over this information in a standardised format on an ongoing basis, making it easier for buyers to compare the nuts and bolts of different trades. “The rules today do for investors what food and drug labelling does for consumers – provide a list of ingredients,” said SEC Commissioner Kara Stein in her prepared remarks. “The rules today do for investors what food and drug labeling does for consumers ” Investors will also have more time to assess deals while they are being marketed, a sticking point for some time between buyers and sellers in the US securitisation market, which grew to US$9.5trn at its 2007 peak. The new rules set a three-day mandatory marketing window, before bankers can start taking bond orders, compared with no specified marketing period currently. “More time is always better for this type of analysis, especially with regard to larger, more complex structures,” said Christopher Sullivan, CIO at the United Nations Federal Credit Union in New York. The finalised transparency requirements will give investors a better picture on how a deal might perform, he said. “Perhaps, it also will reduce what has been a longstanding over-reliance on credit rating agencies by investors for determining asset quality,” he added. Private deals get pass And while the rules will equip buyers with more time to make their investment decisions in the public market, private 144A deals will not be required to adhere to the same disclosure standards. “That was a big surprise,” said Jason Kravitt, a partner at Mayer Brown who specialises in securitisation. “The private 144A market is a huge market, and it is one advantage the US has over other countries.” Even so, he expected private offerings to eventually adopt many of the newly finalised disclosure rules, since first-time issuers typically tap the private market while they are small, but eventually go the public route to reach a broader base of buyers. “But for now, there is no formal rule requiring them to do so.” No reprieve for buyers this autumn Even so, the full set of rules will not take hold for up to two years, leaving investors to fend for themselves in the heavy post-Labor Day pipeline of deals. In September alone, a record US$15bn in fresh CMBS supply has been forecast, a figure well above the post-crash monthly high of US$10.9bn in November 2013, according to JP Morgan research. And while the SEC also voted to make ratings agencies more transparent and less prone to conflicts of interest, those rules will also be phased in over a two-year period starting later in the autumn. “More time is always better for this type of analysis” Some players in the CMBS market have already raised red flags about potential flaws in the ratings process, with more agencies recently declining to assign their marks to all but the highest credit quality tranches. Two of the big three ratings agencies have started to selectively grade only the top 30% credit enhanced Triple A classes of some new conduit CMBS offerings. Standard & Poor’s first did so in the spring, while more recently Moody’s followed suit. “Jefferies continues to believe investors should insist on an ‘all-or-none’ ratings policy – either all ratings across the capital stack are used or none at all,” the firm’s analysts wrote in a recent report.

Despite widespread plunges in secondary market bond valuations and escalating tensions in Ukraine, some Russian issuers are still hopeful that there might be a window to print new deals in September. Alfa-Bank confirmed on Thursday that it was still considering issuing bonds as early as next month. “We will be ready in September and will see what the market is like at that time,” Mike Lawrence, Alfa-Bank treasurer, told IFR. Alfa-Bank completed US and Asian non-deal roadshows in July. Meanwhile, Lukoil said at the beginning of August that it was considering coming to the market in September or October. A company spokesperson could not comment on Thursday whether this was still a possibility. If these firms do decide to come to the market, they will be placing bonds after a clear rise in anti-Russian rhetoric from Ukraine. “Recent Russian actions clearly demonstrate that Moscow is bluntly drawing Ukraine and the entire world into a full-scale war,” said Ukraine’s ministry of foreign affairs in a statement. Ukraine accuses Russia of providing troops and weaponry to the separatist movement in Eastern Ukraine – a charge that Russia has denied. Evidence appears to be stacking up against Moscow’s claim that it does not have a military presence in its neighbouring country, with NATO stating that there are “well over 1,000 Russian troops operating inside Ukraine”, Reuters reported. Ukraine industrial hub Donbas has seen fighting between pro-government forces and separatists. Donbas is such an important part of Ukraine’s economy that should it break away from Ukraine, it could cause a wave of debt restructuring, according to Tim Ash, head of emerging market ex-Africa research at Standard Bank. Ukraine accuses Russia of providing troops and weaponry to the separatist movement in Eastern Ukraine – a charge that Russia has denied “For Kiev, any scenario that leaves Donbas out of its control is unacceptable as rump Ukraine is probably not sustainable without Donbas,” said Ash. “Investors probably don’t realise that an end to fighting now, and a scenario where Donbas remains in Russian hands, probably means that a debt restructuring for rump Ukraine would probably be inevitable.” Ditching Russia Whether investors understand the ramifications of Donbas leaving Ukrainian control or not, they have responded to the increased tensions by dumping Russian debt. “Russian corporates have been hit hard,” said one trader, who added that they were down one to three points. Lukoil’s notes due 2023 dropped more than two points to 91.46 on Thursday, according to Tradeweb. The Russian sovereign’s 2030 notes also lost more than a point, dropping to 112.007 after starting the day at 113.4. “Ukraine is also lower,” added the trader. “The rest of Central and Eastern Europe is heavy.” CEE sovereign bonds rose earlier last week on the back of a wider lift among European peripheral countries in anticipation of looser monetary policy from the ECB. Bulgaria’s 10-year notes due 2024, for example, halted six straight sessions of rises. The bonds were up almost two points from the beginning of the week to close at 100.4 on Wednesday. They were trading at 100.304 late on Thursday afternoon. The problems in Russia and Ukraine appear to be contained within the CIS and CEE, according to the trader. “The rest of the world is carrying on like nothing has happened,” the trader said. New roadshow announcements from South Africa, Bahrain and Burgan Bank late last week certainly seem to validate this view.

Blackrock Solutions has been appointed by the ECB in a consultancy role in its preparations for a programme to buy ABS, Reuters reported last week. Blackrock will provide advice on the design and implementation of a potential purchase programme, but all final decisions will be taken by the ECB itself, Reuters said citing an ECB spokesman. This moves comes as expectations grow about the central bank stepping in to purchase ABS, fuelled by bank president Mario Draghi’s comments on August 22 that the ECB’s “preparation for outright purchases in the asset-backed security markets is fast moving forward”. The hiring of an experienced solutions managers adds another level of oversight to the process. And one senior trader said that “politically, having a big name as a consultant helps”, but others are not convinced. A head of ABS trading said the ECB was already the biggest investor in the ABS market and wondered why the presence of Blackrock was necessary. The central bank began accepting senior securitised tranches in repo agreements after the start of the financial crisis to provide emergency funds to banks that would have faced painfully high credit spreads, if they were able to sell a deal at all, and so would already have some systems in place. According to ECB data, the amount of ABS eligible for the central bank’s Eurosystem peaked at €1.29trn in 2010, of which €490bn was pledged as collateral (after valuations and haircuts). In that year, ABS accounted for just over 24% of collateral used. Both the outright number and percentages have fallen since then, but the ECB still has a significant exposure to the European ABS market. According to the central bank’s numbers, as of Q2 2014, there was €684.2m of eligible ABS, of which €300.9bn was used as collateral out of €1.979bn, or 15%. There is actually less ABS pledged at the ECB than covered bonds as of the end of the first half (€300.9bn versus €360.9bn).

Hochtief, DIF and Kemna have signed the €600m financing package for the availability-based A7 motorway PPP in northern Germany, according to PFI. The deal, issued through Via Solutions Nord GmbH Co KG, is the first PBCE project bond financing in Germany. The financing included a €440m 29-year project bond rated A3 by Moody’s. The bond was priced based on a margin in the swaps plus mid-100bp region, with a coupon of 2.957% (according to Moody’s). It was privately placed with the EIB and six other investors, including institutional investors from Germany, France, Canada and Australia. The EIB provides the project bond credit enhancement (PBCE), for a one-and-a-half-notch uplift, through a €90m subordinated loan, covering about 20% of the project bond. The EIB also bought €80m of the bonds. The PBCE will only cover the four-year construction phase, serving as a first-loss piece, and terminated once the project become operational. Taking a loan over four years as opposed to the life of the project lowered the cost of the credit enhancement, while still keeping a strong credit rating profile. Societe Generale and Credit Agricole-CIB were arrangers and joint lead managers. The banks also provide an €80m milestone bridge facility, while the sponsors will put in up to €50m of equity. The A7 project involves the widening of a 65km stretch of the A7 north of Hamburg from 2x2 lanes to 2x3 and 2x4 lanes between the junction of Bordesholm and the interchange of Hamburg-Northwest. The road is the main motorway connecting Germany and Denmark. Construction will last four years, beginning in September and terminating in 2018. The contract also includes the maintenance of a further 59km stretch of the road between Neumünster-Nord and Hamburg-Northwest. The PPP will last 30 years in total. The project company will be remunerated with availability payments, carrying no traffic risk. The financing has a deferred drawdown profile, and the first disbursement is scheduled for September 2.

Portfolio manager ICE Canyon LLC’s US$2bn pass-through note facility backed by emerging markets credits is expected to launch on September 3 with an initial offering of US$180m through ICE Global Credit (DCAM) Fund Limited, according to the programme document. The portfolio manager believes there are significant opportunities in the global and EM credit universe, highlighting three key forces driving the scale and timeliness of the market opportunity. These are significant dislocations in global credit markets, widening demand/supply imbalances in EM credit, and diverging EM growth and credit cycles. The manager also believes that “beta is out and alpha is in, and differentiation and structural reforms will be the linchpin to medium term outcomes.” EM credit will, over time, achieve attractive total returns over a range of outcomes: equity-like total returns from income and capital appreciation on the upside, with lower risk and volatility versus equities on the downside, according to the document. The investment targets for the issuer will cover all EM sectors and global credit opportunities across loans, bonds, special situations and credit derivatives. These include investment-grade bonds, high-yield bonds and private placements, syndicated bank loans, special situations financing, local currency credit opportunities, publicly listed equities, sovereigns, debt/equity conversions, restructuring recapitalisations, special situations (this includes total return enhancements such as equity kickers and also turning around long portfolio positions with weak fundamentals to stronger fundamentals resulting in tighter spreads) and distressed debt.

The latest default study by S&P is a welcome reminder that European structured finance has actually performed well since the crisis, with cumulative default rates significantly lower than in the US. Cumulative defaults between mid-2007 and the second quarter of this year were just 1.58% in Europe. This is up on the first-quarter figure of 1.54%, but being cumulative means it will only go up over time. By comparison, the US market was way back at 19.30%. Over the past seven years, around one third of European bonds rated Triple A have been downgraded, and around 70% of the notes outstanding have redeemed since mid-2007. And as of the second quarter, the 12-month rolling European default rate dropped to 0.16%, the lowest since Q1 2010, from 0.24% in Q4 2013. The default rate in ABS was just 0.02%, with RMBS marginally higher at 0.1%, structured credit at 0.39% and CMBS at 2.38%. Consumer asset securitisation continues to outperform its corporate counterparts, with a cumulative default rate of just 0.06% versus 5.2%. The 12-month downgrade rate has stabilised at a three-year low around 14.8%, partly due to upgrades of some Spanish ABS and RMBS (62 tranches in June) after the agency raised the sovereign, and also due to the fading effect of the agency’s European CMBS criteria roll-out. The agency said only 1.06% of bonds rated Triple A in mid-2007 have defaulted.

Traders reported improved bids in peripheral paper last week, while prime bonds from core Europe also received some client queries. Being August, and the last week of the month at that, volumes were quite low. Expectations of the ECB stepping in to buy ABS in the near future are boosting some sectors, to the extent that more batches of weak data are not having as negative an impact on prices as people might expect. In fact, the data sets are being viewed as further incentives for the ECB to start buying. Italian and Portuguese paper is among those benefiting, with Berica ABS 3A offered at 94bp–95bp, and bid inside 100bp last week. The cash price was around 100.30/100.50, having covered at 100.235 or 100bp a week earlier. Banco Espirito Santo’s Lusitano programme also traded up last week, regaining almost all the ground it lost during the fall-out associated with its parent company. Lusitano 5A was around three quarters of a point higher at 90.50 mid-market last week, but still down from the 92 handle highs of June. Lusitano 4A, meanwhile, was around 91.30, still almost two points off its high in late June. Elsewhere Lusitano 3A traded at 92.80, with a discount margin of 137bp, a trader noted. The Magellan deals from Banco Comercial Portugues also traded, but slightly wider, with series 3A at 91.00 or 141bp and series 4A at 91.40 or 157bp. In Spain, a €20m slice of TDA CAM 8A traded from a BWIC back at its June highs. It traded at 92.55 or 130bp. The cover from the list was 92.30. Morgan Stanley analysts wrote at the start of the week that they saw further potential for tightening in the periphery as the potential for an ECB ABS purchasing plan has not yet been fully been priced in. The analysts have a year-end target for Spanish senior RMBS of 75bp–80bp, with Italian and Portuguese paper 5bp–10bp back. These margins represent two to three price points upside from current levels, which they base on two factors. The first is that valuations are still attractive. With general senior peripheral RMBS levels in the 105bp–140bp range, most bonds are still 15bp–20bp wider than their June tights. In addition, the spread differentials between peripheral RMBS over government bonds and core RMBS are at recent highs. And as the ABS market is not pricing in concrete announcements on purchases in September, they see good upside optionality at the current levels. Their second point is based on fundamental and technical risks being low. Peripheral countries, except Italy, are recovering, and collateral risks remain well contained, they wrote. A number of rating upgrades on the back of sovereign action and collateral performance have also been supportive. And as more bonds move back to the Single A bucket, they expect more real money and bank demand. So even limited purchases of ABS are likely to have a significant technical positive impact on spreads. Contacts also reported real-money interest in core products such as Dutch RMBS and autos, and a UK buy-to-let/non-conforming bid list traded on Friday morning in line with expectations. The largest ticket was a £20m piece of Ludgate 2006-1 A2A, covering at 93.86. Looking to this week, a €15m slice of Aeolus 1A, which securitises payments owed to the Greek government for using its airspace, is due to trade on Tuesday afternoon.

Fitch has withdrawn ratings on the Class A3 of EMF-UK 2008, a securitisation of first-charge, near-prime and sub-prime residential mortgages originated by Southern Pacific Mortgage, Preferred Mortgages, Alliance and Leicester, and Matlock Bank, in order to rate the newly created Classes A1a, A2a and A3a as AAA, AA and A respectively. Following the bankruptcy of Lehman Brothers, which acted as currency swap provider for the deal, a stipulated claim amount of US$75m had been agreed to under termination and settlement agreements. Until July 2014, aggregated proceeds of US$50.3m were pulled together, representing about 67% of the stipulated amount. These were converted into £29.8m as part of the restructuring and combined with the existing fully-funded cash reserve, Fitch said. Various payments were also made using cash recoveries from the terminated hedging agreement, supplemented by a reserve fund of £1.5m. On the September 2014 interest payment date, £31m was put towards restructuring costs, a payment to residual certificate holders, the setting-up of a reduced £1.1m reserve fund, and partial redemptions on the Class A and B notes. Following the partial redemptions, the current level of credit support available to the Class A1a, A2a and A3a notes totalled 32.5%, 25% and 15.8% respectively, the agency said. From the September 2014 payment date, principal receipts up to £3m will feed into a liquidity reserve, which will cover interest shortfalls on Class A1a notes, and, subject to 50% principal deficiency ledger triggers, Class A2a notes. Following a full depletion of the fund, the transaction structure now also allows for principal to be diverted to cover interest shortfalls on the Class A1a notes and, subject to 50% PDL triggers, for the Class A2a and A3a notes, Fitch said. Windermere X Class D to switch servicer: Cheyne proposed as rep for Brookland A meeting has been convened for Class D investors of Windermere X with the aim of replacing Brookland Partners with Cheyne Capital Management as controlling class representative on the Bridge, Built, Lightening Dutch and Tresforte loans, as well as any others that become specially serviced. The controlling class is the investor holding at least 25% of the outstanding amount of the most junior bonds. Brookland was only officially appointed in April following an investor meeting of Class E holders in March. However, that tranche has since been redeemed to leave the D notes as the most junior. Other holders are being asked to contact Cheyne about the proposals. Quorum requires two votes holding at least half the notes to agree. Leo-Mesdag refinancing starts: notes partly repaid on August 29 The first phase of the refinancing of Leo-Mesdag took place on August 20, with €218.6m to be applied towards the repayment of the loan and then the notes on the initial payment date of August 29. An amended refinancing plan was announced by the borrower, IEF Capital Berlage Zuid, on May 22 and agreed at investor meetings on June 6. Auto ABS 2012-2 gets rating boost: Fitch rewards credit support Fitch upgraded Auto ABS 2012-2 Class A notes to AA+ due to a significant boost to the available credit enhancement since the deal closed in November 2012. The deal securitised an original €621m pool of auto loans originated by the Italian branch of Banque PSA Finance, a subsidiary of Peugeot. Class A notes have already amortised to about one third of their initial balance, resulting in 36% of credit enhancement in July from 20.4% a year earlier. Fitch said that, given the current short average remaining term of the portfolio of 26 months, Class A notes are expected to be fully redeemed in about one year. Cumulative defaults of 1% of the initial pool balance as of the end of June were lower than Fitch’s base case (2.8%) for the same point of seasoning, mainly thanks to the strong performance of loans extended to individuals to buy new cars, which represent the largest sub-pool. The agency has rev

The first sterling high-yield mandate hit the screens on Friday, but Double B rated Travis Perkins will have an investment-grade execution, according to a banker on the deal. Proper high-yield deals are in the offing, however. One high-yield banker said that they have a Single B rated debut issuer set to announce a deal on Monday, which will be issuing equity as well. “European HY always starts off a bit slower than expected, but if we get this deal it will be good for the rest of the market,” he said. “Primary needs to build confidence in the first couple of weeks of September before we see a rush of deals, given the state of the market when we entered August and the secondary performance of deals priced in July.” In the secondary market, the iTraxx Crossover was bid a touch tighter at 237bp at midday on Friday, having reversed most of Thursday’s widening following the escalation of events in Ukraine. The cash market continued to be results-focused, however. French retail continued to get a battering following Maisons du Monde’s poor results on Thursday, as clothing retailer SMCP’s 8.875% 2020 bond was similarly knocked back after it posted Q2 figures. The paper was quoted as high as 108.50 first thing, according to Tradeweb, but had fallen to 106.40 by mid-morning. Spanish bus company Avanza’s 9.5% 2019 unsecured bonds continue to soar meanwhile, following Thursday’s results. The bonds jumped from 89 to 92.75 on Thursday and shot up further to 95.50 on Friday. While Ebitda declined at the group, news that owner Grupo Ado had renegotiated its RCF and was bidding for new contracts has given investors greater confidence. “The numbers weren’t great, but everyone took comfort from Ado’s greater involvement, as no one really knew what they were doing before,” said one high-yield investor. “They need the new contracts to off-set the loss of their Zarragosa concession.” Grupo Ado acquired Avanza in August last year, making use of the portability clause in bonds put in place by previous owner Doughty Hanson.

The retrenchment in banks’ rates trading businesses shows little signs of abating, as what was once the engine room of investment banks’ revenue streams continues to feel the squeeze from the combined weight of tougher regulations and record low interest rates. *Updates fourteenth paragraph to clarify position in euro swap trading The decision from rates trading behemoth Barclays to overhaul its operations earlier this year, and hive off exposures into a non-core unit, was viewed as symptomatic of a broader malaise in the asset class, which has already seen deeper cuts at former stalwarts including Credit Suisse, RBS and UBS. While some insurgents see this as an opportunity to break into the big league, many predict that the hefty capital requirements under Basel III – which hit the rates business particularly hard – will consolidate the wallet towards a handful of dealers that can meet the high barriers to entry. And even among the largest firms, few continue to claim the universal banking mantle in rates trading as a sharp rise in costs has forced most dealers to pick their spots. “Ten years ago, the rates business at most dealers was part of a universal model across their fixed income offering. Now, we are one of the very few firms that subscribe to that model,” said Charles Bristow, co-head of EMEA rates at JP Morgan. “Rates products are often the bedrock upon which investment portfolios and risk management strategies are built for the long term. The customer base requires you to be there through thick and thin, and that has always been our aim: to be stable through the cycle.” Two years ago, rates products were the cash cow in investment banks, raking in 21% of their revenues – more than DCM, ECM and M&A combined, according to UBS analysts. Overall fixed income revenues at the top 14 dealers peaked at US$131bn in 2009, as markets gorged on a flood of central bank liquidity. But the healthy top line masked structural issues. The largest rates dealers of the past decade were able to attract flows thanks to top credit ratings and putting their enormous balance sheets at clients’ disposal. The new regulatory world has turned this model on its head. “The old investment banking model of offering 20,000 different products is dead” “The regulatory push towards clearing and higher capital requirements is a great leveller and helpful for us in expanding our derivatives business. We’ve seen growth in the quality and number of clients that are doing business with us,” said Matt Reader, global head of rates at Nomura. Central clearing of derivatives has reduced the importance of credit ratings while Basel III and national regulations have made balance sheet an expensive commodity that can no longer be wielded carelessly to attract flow. “The old investment banking model of offering 20,000 different products is dead. The new paradigm involves a simpler, narrower set of products that deliver what clients need,” said Mike Bagguley, global head of macro products at Barclays. Legacy issues The rates business is hit harder by capital charges than most asset classes due to its long-dated and, in some cases, uncollateralised nature. While few credit products have tenors beyond 10 years, interest rate swaps go out to 50 years and 30-year swaps are relatively commonplace, meaning these RWA-heavy exposures could clog up balance sheet for decades to come. Firms that established themselves as bulge-bracket players in the past decade have had huge swaps books to manage down. “We have historically been conservative on long-dated business, which means we don’t have real issues on RWAs,” said Mathieu Gaveau, global head of European G-10 rates trading at BNP Paribas. “Long-dated structured swaps are hard to get out of and act as a significant drag on profitability. Since we don’t have profitability issues, we can invest and adapt to regulatory changes without being constrained by a high capital base.” Gaveau highlighted Europe and