From the collapse of Lehman Brothers in September right up until the second half of November, US banks were entirely absent from the debt capital markets. It is a sudden turning off of the tap from a key source of funds.
In the first quarter of 2008, US banks and financial issuers had sold $97.5 billion of debt in the US corporate bond market; in the second quarter, they sold $133 billion, issuing at roughly the same rapid pace as in the second quarter of 2007, before the financial crisis had even begun. Then...nothing.
Spreads on bank paper gapped out to extraordinary highs, implying expectation of imminent and widespread defaults, during the fears of systemic meltdown in September, but as the US government and the Federal Reserve hurried to take over troubled institutions, invest in bank capital, inject liquidity and guarantee funding, they soon narrowed again.
When, the US Treasury injected $214 billion of capital into 60 banks through the so-called Tarp programme in October, five-year CDS spreads of US banks tightened – in some cases, halved – at a stroke. Citigroup’s spread came in from 351 basis points to 165bp, JPMorgan from 165bp to 80bp, Wells Fargo from 180bp to 80bp, Bank of America from 180bp to 100bp and Goldman Sachs’s from 554bp to 150bp.
But none of them came back to the primary market.
In the first half of November, US investment-grade corporates began to issue bonds again, raising $15 billion, implying a monthly volume ahead of the $21 billion in October and the average of $25 billion since June. And these bonds started to perform, with deals in October and November tightening by about 25bp in the first two weeks after issuance, so lowering the new-issue concession to secondary trading levels required to get new deals away from 100bp to between 60bp and 90bp.
But still no banks issued.
Their continued absence reflects the severe difficulties the Federal Deposit Insurance Corporation has run into with its efforts to reassure debt market investors of the safety of investing in US bank bonds. On October 14, coinciding with the Treasury’s injection of capital into US banks, FDIC chairman Sheila Bair unveiled plans to allow banks to roll maturing senior debt into new issues fully backed by the FDIC with a guarantee running until June 2012.
The FDIC’s and the Treasury’s fear was that the guarantees for bank debt then being provided by European governments might leave US banks at a disadvantage. Bair decreed that the FDIC’s temporary liquidity guarantee programme would “unlock inter-bank credit markets and restore rationality to credit spread. This will free up funding for banks to make loans to creditworthy businesses and consumers.”
But the plan has backfired. The banks themselves rebelled against the form of the guarantee and its cost and, as the process for overcoming these objections and reworking the programme dragged on, so a plan intended to ease bank issuers back into the markets has had the reverse effect: it has frozen them out.
The head of FIG at one US bank says: “Until there is clarity on this programme, issuers will remain wary of issuing and investors will remain wary of investing. Many banks are studying the comparative all-in cost of using the guarantee but it’s significant that none has issued yet and I think they will hang on for as long as they can without doing so.”
Banks have many objections to the scheme – by mid-November the FDIC had received almost 300 comment letters, many itemizing key weaknesses – and the initial deadline for banks either to opt in or out of the guarantee scheme had been put back from mid-November to early December, suggesting that any new issues of bank debt covered by the guarantee might not appear until the run-up to Christmas.
There are two overriding concerns. The first is that the guarantee is too weak, the second that it is too expensive.
The FDIC initially proposed that banks seeking cover be obliged to pay a 75bp insurance premium on all new senior unsecured debt, including even overnight funding, issued up until June 2009 and covering maturities up until three years after that date.
Banks point out that now, partly thanks to the largesse of the Federal Reserve, there is little constraint in the availability of overnight funding and argue that they should not be required to pay a 75bp fee for an unnecessary guarantee that would make such funding uneconomic.
“There are so many government programmes now, they are starting to overlap,” says one banker.
Even more crucially, banks say that the form of the guarantee is inadequate to the intended aim of attracting traditional rates-market investors to buy bank debt. The FDIC proposal guarantees that investors will be able to recover principal in the event of bankruptcy. It’s the kind of guarantee that perhaps comes naturally from a body designed to protect bank depositors. But rates investors used to buying only government bonds and fully government-guaranteed agency bonds will demand an explicit guarantee of full and timely payment of interest and principal. Rates investors have no desire to chase up recoveries from an institution that has gone into receivership or bankruptcy.
As the Thanksgiving holiday approached, bankers in the US hoped that the FDIC would be persuaded of the need to beef up the guarantee. A key meeting was scheduled for Friday 21 November. Some noted Treasury secretary Henry Paulson’s comments of November 14 on the future of the government-sponsored enterprises he had taken into conservatorship in September and wondered whether this might extend to the TLGP. “In my view, government support needs to be either explicit or non-existent.”
Banks were pushing for further concessions. They want reduced fees and variable fees depending on the worth of a guarantee to the debt instrument being issued. Rather than having to either opt fully in or out of the guarantee scheme, banks want to reserve the right to issue guaranteed debt or non-guaranteed debt at their own discretion. That raises the prospect of a gradated bank debt market with fully government-guaranteed debt at the low-risk, low-spread end of the continuum, non-guaranteed senior unsecured debt attracting investors seeking higher spreads at the high-risk end and, some bankers suggest, maybe covered bonds – a market whose praises Fed chairman Ben Bernanke has been singing – somewhere in the middle.
It is entirely possible that, as soon as an acceptable final form of the rule is produced, a flood of bank issuance might follow. Bulls of bank bonds – almost every bank research department earnestly, and with no hint of irony, argues that bank bonds are a good buy – suggest that a guarantee will not only lower the spread for banks on guaranteed paper but also pull in the spread on non-guaranteed bank paper by reducing the supply of such bonds.
It remains to be seen whether, when US banks do finally issue guaranteed debt, this new supply will widen the spread on existing agency bonds, as it did in Europe, and even Treasury bonds themselves.
But the ability of banks to last so long without access to the debt capital markets is, in itself, suggestive. Liquidity has returned. Perhaps banks don’t need so much funding because they intend to lend less – they have been deleveraging and tightening lending standards – and have been attracting deposits.
And while Bair has urged banks to sign up to the programme, some of the most withering criticism has concerned the requirement for banks to display prominently any decision to opt out from the guarantee.
Deneen Stewart, general counsel to ING Direct, wrote on November 13 to the FDIC saying: “Expressly stating that we’re opting out of obtaining excess insurance on a product we don’t carry – akin to requiring a McDonald’s restaurant to post a health warning concerning consuming raw fish in sushi (which it does not offer) – seems inherently meaningless.”
Honestly, the FDIC must think: you try to help some people... and they don’t even thank you.
