Comment on this story
As summer draws to a close and the sunbeds begin to pile up, European banks’ seasonal need to raise capital resurfaces. Financial institutions have been issuing heaps of senior debt in recent months, but this week sees fresh supply of the riskiest form of subordinated debt – evidence that investors are pouring fresh money into the region’s banks.
New subordinated debt deals offer the best gauge of demand after the Credit Suisse Group AG implosion in March prompted Swiss regulators to forgive the lender’s $17 billion of AT1 debt. The obliteration of these bondholders effectively shut down this market for several months. Supplemental Tier 1 capital bonds, also known as contingent convertible bonds, allow regulators to zero in on investors in the event of a bank failure. The asset class offers the highest returns for lending to financial companies, but comes with the greatest risk of loss. While some deals have been completed in recent weeks, such as BNP Paribas SA’s $1.5 billion perpetual issue at an 8.5% rate in early August, the sector has yet to fully regain confidence.
The prospects are improving. 13 new European bonds worth more than 18 billion euros ($20 billion) were closed on Tuesday, the most since June. Six of these were from financial issuers, with some banking deals on the riskier side of the spectrum. Another five financial firms tapped into the market on Wednesday.
The highlight of the week was a €750 million AT1 offer from Belgian lender KBC Group NV with 8% AT1. The order book exceeded EUR 2 billion even though the offered yield spread was reduced by almost 40 basis points during the placement process. Further evidence of increased risk appetite was the fact that Italian lender Banca Monte dei Paschi di Siena SpA, still majority state-owned, secured a four-year senior preferred contract with a coupon below 7%. It shows that the summer lull is coming to an end and investor demand is returning.
European subordinated bank bond yield spreads relative to swap rates have narrowed steadily for most of the March hike. What would really boost new subordinated bank debt issuance would be a potential AT1 deal by UBS Group AG. It would be a major test of how investors view the Swiss national champion as it faces the mammoth task of digesting the takeover of its key domestic competitor and setting the temperature for the broader subordinated debt market.
With UBS facing upcoming call dates on a large US dollar-denominated AT1 deal as well as a smaller Singapore dollar issue, the lender may choose to reestablish its market presence. As soon as the half-year results are available on Thursday, a deal could be announced that will include an update on how the Credit Suisse integration is progressing. Existing UBS AT1 bonds are trading around 100 basis points above equivalent BNP bonds in the secondary market, so a new dollar issue would likely offer a coupon close to 9.5%.
Other banks could also enter the market. France’s Societe Generale SA has announced it will terminate one of two possible existing AT1 deals that may require refinancing. Banco Santander SA can also cancel an existing deal, although the Spanish lender may need to be more generous with pricing. The senior unsecured new £500m ($633m) six-year new deal last week came at the end of a string of new sterling issues and could not be fully sold to investors, leaving lead managers with excess shares . The book was covered more than one and a half times, but a reduction in the stated credit markup in the final pricing resulted in orders being withdrawn. Investor appetite is there – but not at any price.
European issuers typically redeem subordinated debt on the first call date, although there is no legal obligation provided it is feasible to issue a replacement at a commercially comparable level to the existing business. It’s always reassuring to have easy access to the highest risk capital. Likewise, investors have much greater confidence in an institution when the perpetual debt is regularly rolled over and they are not tied down as holders. However, regulators are careful to ensure that banks have sufficient Tier 1 capital, so new issuance often stalls in times of stress as banks are discouraged from exercising these call options.
According to Eugene Fama’s efficient market hypothesis, financial markets have no memory. There is still a long way to go before normal business operations resume in European capital markets, but it would certainly support the theory if UBS nailed a successful AT1 deal before the end of the year. Renewed activity this week suggests that investors’ focus is shifting back to potential future juicy returns rather than worries about past troubles – good news for European banks.
More from the Bloomberg Opinion:
• UBS put salt in the wounds of AT1 holders: Chris Hughes
• How I Divorced My Bank to Get a Return on My Money: Chris Bryant
• Italy’s unexpected bank tax fails its stress test: Marcus Ashworth
This column does not necessarily reflect the opinion of the editors or of Bloomberg LP and its owners.
Marcus Ashworth is a columnist at Bloomberg Opinion, covering European markets. Previously, he was chief market strategist for Haitong Securities in London.
For more stories like this, visit Bloomberg.com/opinion
Comments are closed.