Despite the finalisation of total loss-absorbing capacity requirements and the Bank Recovery and Resolution Directive, the outlook for European bank capital issuance in 2016 looks as unclear as ever.
The region has come up with a pot pourri of solutions to the various regulatory requirements and the incentives for issuance vary widely from jurisdiction to jurisdiction. What is clear, however, is that both issuance and investor appetite are set for a marked change during the year.
|Barry Donlon, UBS|
AT1 bank capital was certainly a good place to be for European investors in 2015.
“This asset class has been extremely resilient because investors have a degree of confidence around the fundamental trajectory of bank credit metrics and their continual improvement,” says Marc Stacey, portfolio manager at BlueBay Asset Management, which runs a dedicated bank capital fund. Indeed, according to CreditSights, at September 30 the average distance to trigger for the leading 32 banks in Europe was 804bp.
“Subordinated debt and AT1 investors can be reassured that there is a decent buffer of equity, which sits beneath them in a bank’s capital structure, to absorb losses,” says Stacey. “Despite all the volatility this year the BAML AT1/CoCo index has returned over 7%.”
There will probably be around €40 billion AT1 issuance in 2016 but as demand accelerates the return dynamics in this part of the market could disappoint.
“A lot of European banks are done and the issuance that we expect is from not very interesting names [from a yield perspective] such as BNP Paribas and HSBC,” says one bank capital specialist.
Stacey has witnessed a surge in interest following the volatility in broader high yield.
“The investor base for AT1 is still relatively small but it is growing rapidly,” he says. “A lot of high yield investors have ex-financials mandates but are increasingly investing in bank capital as the volatility adjusted returns have been so strong, especially in comparison to the rising idiosyncratic risk which has become more prevalent in their own traditional high yield universe.”
For those funds that can buy it, AT1 is the obvious place to be, given the bail-in rules that have been ushered in with BRRD. That is good news for issuers as yields are likely to come in.
However, a more interesting dynamic is in play between senior and tier-2 issuance. Several banks brought tier-2 deals in late November, including a €750 million deal from Allied Irish Banks (just prior to its AT1 debut), a €750 million deal from BNP Paribas and a samurai tier-2 deal from BPCE in early December.
France is likely to be fertile ground for subordinated issuance in the near term, as it remains unclear whether statutory subordination of senior bonds will be introduced, as it has been in Germany.
BNP Paribas had a TLAC shortfall of around €34 billion in early November, according to CreditSights and has indicated that it will issue between €2 billion and €3 billion tier 2 a year until early 2019.
“In parts of continental Europe, particularly France, it is still very unclear what will qualify as bail-in senior debt,” says Donlon. “So the argument to buy tier-2 bank paper there, rather than senior makes more sense, as you know your position in resolution and are paid for that risk.”
|Marc Stacey, BlueBay|
He estimates tier-2 issuance for the year could be €45 billion as banks look to optimise their capital structure and move to a minimum of 2% of RWA’s in lower tier 2.
One driver for tier 2 will be the rating agencies and their removal of credit from bank ratings for implied government support. The additional buffer required to mitigate this (additional loss-absorbing capacity) will drive issuance as banks seek to shore up their senior curve by issuing more tier 2.
S&P analyst Giles Edwards wrote in a December 2 report: “As we move through 2016, we will be monitoring closely the progress that banks make in building their ALAC buffers, and could yet take negative rating action if a bank’s ramp-up of ALAC appears likely to fall short or be materially delayed.”
The focus for tier-2 issuance will be the continental European banks. The case for tier-2 versus holdco senior from a UK or Swiss bank is slim given that holdco debt has become far more yieldy as BRRD becomes better understood. JPMorgan expects $64 billion equivalent senior holdco issuance from Europe in 2016.
“Tier 2 estimates are always grossly exaggerated,” says Donlon. “The German solution together with holdco issuance from the UK and Switzerland will detract from tier-2 issuance. However, even in jurisdictions where you have a statutory solution for MREL and TLAC banks will continue to issue T2 to protect their senior ratings,” he says.
“In order to estimate tier-2 volumes for 2016 you would have to make broad-based, generic assumptions without complete information – they will be elevated though.”