With investors crowding into European periphery government bonds at the start of 2014 and driving down secondary-market yields, bank issuers were quick to ride the enthusiasm in the primary market. Irish, Portuguese, Spanish and Italian banks launched senior unsecured bonds in the first weeks of January, amid signs that they are in a positive feedback loop.
The mere ability to issue senior debt at reasonable spreads is in itself a positive signal of market acceptance that these banks are past the worst. As more bond investors buy into the broad macro recovery trade, establishing a lower cost of funding without encumbering assets by resorting to ABS or covered bonds offers a tantalizing prospect of improving net interest margins for periphery banks.
Should economic recovery boost loan demand, that will drive up profitability. Investor concerns that the European Central Bank might uncover previously unrecognized bad loans and require higher provisioning from European banks during its asset quality review appear to have been quashed in the rush to buy.
UniCredit, Bank of Ireland, Bankia, Santander Consumer Finance, BBVA, Banca Popolare, Intesa Sanpaolo, Banco Popular Español and Banco Espírito Santo all issued senior unsecured bonds at the start of the year, most benefiting from substantial over-subscription that allowed price tightening from initial guidance.
Last October Banco Popular paid an 11.5% coupon on an 500 million additional tier 1 capital trade. Although those interest payments are tax-deductible and proceeds counted as capital, thats still a hefty coupon on any liability for analysts to compute into a banks business model. In January, the Spanish bank paid a 2.5% coupon on a 500 million three-year senior bond, the lowest fixed-rate coupon it has ever achieved. The deal attracted 1.2 billion of orders, with UK-based real-money accounts to the fore, allowing final pricing at 190 basis points over mid-swaps after initial guidance at 200bp over.
|Sébastien Domanico, global head of financial institutions origination, debt capital markets, at Société Générale|
Technical considerations also helped bank issuers. "The first few weeks of January are always a bit unusual as investors want to put money to work and issuers get ahead of their calendar," says Domanico. "But while volumes of periphery bank issuance have been decent they have not been massive. For banks in Europe, redemptions are likely to be greater than new issuance this year. Most are not growing assets. They are still contracting. And the LTRO is still there and may even be extended. So investors looking to pick up higher-yielding paper either in subordinated debt from core banks or senior debt from the periphery have less opportunity to be picky." By January 24 European bank DCM volume was running at 19% below the 2013 rate.
Have investors lost their discipline in the rush to grab yield? At the start of the year, traders were discussing with Euromoney the tactic of going long periphery government bonds as they rallied hard and hedging by selling financials. This trade quickly became swallowed up in the rush to buy and periphery banks and governments moved in lock step. Similarly, banks that had been lightening up their holdings of government bonds at the end of 2103, amid fears of how their sovereign exposures might fare under an ECB stress test, stopped selling as the sovereign rally took hold, traders tell Euromoney.
The day after the Republic of Ireland had attracted 14 billion of orders for a 3.75 billion 10-year sovereign bond on January 7, Bank of Ireland launched a 750 million five-year senior unsecured bond that attracted a 3.7 billion order book, dominated by high-quality buy-and-hold accounts according to joint bookrunner Citi, some putting in 200 million orders. After initial guidance at mid-swaps plus 225bp, the deal priced at 210bp over. It probably looked like a good buy a few days later when Moodys upgraded Ireland and sovereign spreads continued to tighten as January wore on.
"It came as something of a relief to investors when it was reconfirmed that policymakers have no current plans to risk weight banks holdings of sovereign bonds," says Alexandra MacMahon, head of EMEA FIG debt capital markets at Citi. "Youd need to be quite brave to bet against the periphery right now. With potential returns in conventional credit markets looking skinny, real-money investors are now joining hedge funds and special situations funds looking to lower-rated credits in addition to longer duration and subordinated debt. Thats why some recovering periphery banks, such as Bankia, can now go straight to the senior unsecured market rather than doing covered bonds first."
She adds: "For Bank of Ireland, we led a seven-year covered bond last autumn that had rallied by almost 80bp, giving investors confidence to support its new senior benchmark. And while some investors may still cite concerns around asset quality, it is clear that the sovereign and the banks are rehabilitating. Ireland looks to be de-coupling from the rest of the periphery and transitioning back towards becoming a core credit."
Buying has not been entirely indiscriminate. A couple of Italian senior unsecured deals sold off as new supply peaked in mid-January: a timely reminder of the potential volatility in bank debt markets. It may yet be that, later this year, periphery banks will be thankful they got senior deals away when they could at low cost and without eating into their capacity to do asset-backed funding.