Borrowers head west to diversify funding sources
“I would say that the theme this year has been on the high number of European banks that have gone to the US. Every European issuer was previously focused on the euro market – building their curves, establishing their investor base. They have all now done that. I wouldn’t say that they are bumping up against any kind of lending limits but let’s say that they’ve explored the boundaries of the euro market,” says Alan Patterson, European head of the financial institutions group at Citigroup.
Patterson points to significant market consolidation as one reason for this trend – many banks are much bigger now. For example, UniCredit and Santander both now have $20 billion borrowing programmes – far in excess of what they had five years ago. So their need for diversification is that much greater. Such currencies as yen, sterling, or Australian or Canadian dollars provide some variety but very little real opportunity to raise significant volumes.
It is this diversification rationale that explains why the volumes in the US extendible market have jumped dramatically, from $57 billion to $72 billion year to date, according to Merrill Lynch. And US issuers are now only accountable for 25% of volumes compared with 2005 where they were responsible for one-third of activity.
“It’s been another cracking year, a combination of new and repeat issuers, and the calendar is looking good right through until the end of the year,” says Andrew Ellis, executive director, money market origination at Goldman Sachs.
“The big thing is that if you break down regionally where the issuance is coming from, over 60% is accounted for by yankee banks,” says Ellis.
Another factor that explains why European banks issuing yankees are choosing extendible notes is that there are few regulatory hurdles to leap. Ellis points out that there are significant documentation advantages in using the extendible as a financing tool in the US markets, as transactions can be executed off CP-style ‘short form’ documentation which is relatively painless – for example, no 1Ob-5 opinion or auditor’s comfort letter - far less pain when compared to standard 144a issuance due to much lower required levels of disclosure.
On a blended basis, this source of financing is also much cheaper than straight five-year funding – by at least five basis points for a highly rated bank. But there is the risk of non-extension, which is why treasurers will have to book extendible financing as money market funds despite the fact that the vast majority of notes do extend.
“You can count on the digits of two hands, maybe three hands, the number of instances where non-extension has occurred. In the majority of cases, even where there has been non-extension, a percentage of those notes remain out-extended,” says Ellis.
There are only about five instances, including the Icelandic banks (Landsbanki, Kaupthing, Glitner), of notes that have been completely unextended in entirety.
These were very name specific and credit specific events. “Even where there has been non-extension, some of the notes remain extended,” says Ellis.
The other entities to be affected were Ford and GM. According to Merrill Lynch some 97% of these notes have been extended.
Another new dimension to extendible issuance is that new issuers to the market have managed to get deals away, which is a further sign of the market’s maturity. There is only a marginal extra premium for being a debut issuer. A Libor-flat first coupon compared with Libor minus one basis point, for instance.
Record supply
“That market has had a tremendous amount of liquidity,” says Sid Prasad, head of the European financials institutions group at Merrill Lynch. Prasad explains that while it has traditionally been the preserve of double-A rated institutions, it is notable that single-A banks are getting great execution.
Prasad points to significant supply being successfully absorbed – $4.5 billion for UniCredit (A1/A+) $3.5 billion for Caja Madrid (Aa2/A+) and $2bln for Natexis (Aa3/AA–) – without a roadshow in 24 hours.
“June 2006 was an all-time record month of issuance, with over $15 billion raised,” Prasad says. “UniCredit issued $4.5 billion of extendible notes in May, via Merrill Lynch, which was the largest bank extendible note offering so far.”
Extendible notes have traditionally been directed to US money market funds, often called 2a7 accounts. These investors have traditionally been quite conservative. As the name suggests, the paper’s maturity can be extended by the investors – they typically have a put once a month. It is this put that makes the note eligible for 2a7 accounts, which are precluded from buying anything longer than 13-month final maturities.
“We have seen a broadening out of the investor base. If you looked two years ago at an extendible trade a normal 13 month/five-year structure would be sold into a fairly narrowly defined investor base. If you look at a standard trade these days it’s not surprising to see up to 35% bought by securities lenders, who in the past would have gravitated to the longer-dated extendible note structures,” explains Ellis.