From paralysis to frenzy: FIG investors hunt for value

A mountain of regulatory changes conspired with a dire economic backdrop to turn fixed income investors off financial institutions for most of 2012. Although the mood changed in the FIG market over the summer, for most of the year high spreads and volatile conditions made access to the wholesale market unappetising for a lot of borrowers.

  • 02 Oct 2012
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Roger Barton, regulatory consultant, MTS and founder, Financial Reform Consultancy  

For their part, investors have had to keep up to speed with plummeting bank ratings, wide bid-offer spreads in the secondary market, and a new world of bank capital instruments.

At the same time, they have had to digest the swathe of crisis-busting rules being hammered out in Europe. The Recovery and Resolution Directive — which introduces the concept of bail-in to European law — is shaping up to be one of the regulations with the biggest impact on how banks operate in the debt markets.

EuroWeek sat down with a cross-section of FIG market participants to discuss the evolution of the FIG markets this year from the buy-side point of view.

Participants in the roundtable, which took place in London in early September, were:

Roger Doig
, fixed income credit analyst, SchrodersScott Fong, head of fixed income sales, UK and
Scandinavia, NatixisGeorg Grodzki, head of credit research, Legal & General Investment ManagementRobert Montague, senior investment analyst,
ECMKatie Llanos-Small, bank finance editor,

EUROWEEK: The last couple of weeks were a bit different, but in general financials have been fairly unloved on the senior unsecured side this year, although that seems to have been balanced out by a smaller amount of funding needs. Is that an accurate characterisation?Georg Grodzki, Legal & General: Fundamentally, financials have remained under a cloud this year. I can point to rating downgrades. I can point to results which were anything between mixed and bad — at least in Europe, with very few exceptions — and continued concerns about the sovereign crisis at any point in time escalating and contaminating the banking sector — which it in fact did.

At the same time, the funding concerns, which very much characterised last year, have been removed.

So we are talking about earnings, solvency, asset quality pressure on banks, and on their business franchise as such, as funding costs are higher than lending spreads.

And despite the rally in the past few weeks, I would maintain that we’re not out of the woods yet as far as those fundamentals are concerned.

EUROWEEK: Is that something you’d agree with, Robert? Robert Montague, ECM: I know financials have been a bit under a cloud, but actual returns have been pretty good, with the best performance being within the most subordinated segments.Grodzki, L&G: Fundamentally...Montague, ECM: Yes, fundamentally. But certainly performance has been very good, clearly. The concerns about funding have not been completely removed, but certainly allayed by the LTRO. Clearly, there’s still work to be done on capitalisation, but banks are certainly in a better place than they were a couple of years ago. As Georg said, earnings are under pressure, or remain under pressure.

Obviously a slightly new element is all the litigation which has arisen a lot to do with the Libor fixing, also in the UK you’ve got various other scandals and so on. But, net-net, with all the ratings downgrades happening, you have got an investor base which is potentially shrinking in size.

EUROWEEK: Scott, are you seeing that on the sales side, that the investor base for financial debt is shrinking?Scott Fong, Natixis: I wouldn’t quite say that it’s been shrinking. Obviously it’s a question of something you fit according to demand. But from our perspective we do see demand in certain areas. We have to distinguish between peripheral and core jurisdictions. I agree with both Georg and Robert that from the fundamental perspective, all of the factors they’ve raised have been a concern. But at the same time banks have gone some way towards addressing the balance sheet concerns etc. This clearly helps them to raise funds and prefund a lot of their needs for next year as well.

So yes, it is true that I think investors, certainly at the start of the year, have shied away from senior unsecured debt. But in the last week and a half or so you have seen the likes of Santander come into the market, not just once but twice — admittedly with pretty short maturities. I think that banks like national champions can still, certainly in this market, get things done.

EUROWEEK: What about the other peripheral credits, away from the national champions, away from the BBVAs and the Santanders of this world?Fong, Natixis: I think that’s the next step with a strong domestic demand.EUROWEEK: Roger, it’s been interesting to see the rally over the last couple of weeks that has brought in those deals from Santander, BBVA, UniCredit, Intesa. Has the rally got further to run? Do you think if it does run further we’ll see the non-national champions on the periphery being able to access the market?Roger Doig, Schroders: Maybe. I think the deals which we’ve just been seeing are coming at quite significant premia to the government curves of the respective governments. To the extent that there is a significant market underweight in those governments at the moment, which needs to be covered, then covering them with the national champion bank paper at the same rating and a significant premium is an attractive way of doing it.

I’m not convinced for the smaller issuers, where you don’t have investment grade ratings, where you have clearly, looking forward, a very significant potential of bondholder loss absorption of some form or another. We don’t know exactly how it would be, whether it would be just at government level, and whether it can also affect the bank senior paper, but we know that that risk is not negligible.

I think it’s very unlikely that you’re going to get much issuance in a senior unsecured format from the smaller failable banks.

EUROWEEK: Do you mean in absolute, once that bail-in framework is in place it’s unlikely that these second tier borrowers will have access — or does it depend on the euro crisis? Doig, Schroders: It doesn’t matter on the bail-in framework. I think the reality is if we look 18 months, 24 months down the road, there is a non-negligible possibility that there is some kind of loss absorption. And we heard comments from ECB in the early part of the summer that they were no longer as committed to supporting senior unsecured in the event, at least, that a bank needs to be liquidated. EUROWEEK: In terms of the money going into the asset class, are you more interested, say, in allocating funds to corporate debt as opposed to financials, or sovereigns as opposed to financials? Have you noticed a swing in that over the last 12 months, and is that going to continue evolving, the amount of cash that actually goes into financial debt? Montague, ECM: From my perspective, I think there’s a lot of opportunities within financials. Mind you, I would say that, being a financials specialist. I think there’s a lot of value out there, but there are value traps as well. But the risk return you can get on some short dated senior from peripheral, some set of callable bonds as well, is tremendous. EUROWEEK: And the money that’s coming in, are you seeing a shift there? Montague, ECM: The mandates are still quite cautious. They all still generally prefer corporates, even though the risk return is definitely skewed, I think, against them now. Grodzki, L&G: You have a number of variables to play with. Even if you are concerned about the sector in respect of the fundamental issues I outlined earlier, you can still play the short end, you can play regions, geographies of peripherals versus cores, and you can play secured versus unsecured, or subordinated versus senior where we’ve got plenty of anomalies and inconsistencies. One has to weigh fundamental reservations against momentum and those mispricings which result from the forced selling triggered by rating actions.

We’ve probably seen the tail end of the buyback and liability management boom, which has now more or less wiped out most of the hybrid and subordinated sector. These offered opportunities to realise some performance, especially if your entry point was low. And the covered bond space was and still is in some parts, very cheap, if you’re comfortable with the data and the legislation.

Doig, Schroders: Coming back to the question about the financials versus industrials, I think you could make the case that actually in most jurisdictions you’ve now seen the worst of the ratings downgrades. You should get an area of stability in northern Europe, at the very least. So the generalised rating shifts which you saw earlier this year are at an end and they should now be quite stable. That, plus the fact that a number of important large issuers have reached an inflexion point at which they’re now no longer net issuers of senior debt — their balance sheets are deleveraging sufficiently so that they’re now no longer large issuers.

I think that is actually quite an interesting turning point which we seem to have reached during the course of this year. And if you put those two together, then I think it’s clear that certain financials, given where they trade versus industrials, are clearly quite attractive. You’re going to get less issuance, you’re no longer faced with systematic rating downgrades, and the spreads versus industrials are quite attractive.

Montague, ECM: You have seen some banks even buy back senior debt, with Lloyds and RBS. The UK banks are quite interesting — they’re flush with liquidity. These guys were historically some of the biggest issuers in the market, and now they are buying stuff back. Grodzki, L&G: I think that’s an important point. The LM exercises, particularly on sub debt right at the start of the year, gave a backstop to the market. And as Rob has mentioned, they have done so in senior debt as well. There was a strong preference among some investors earlier this year for avoiding financials in favour of corporates. While this stance has softened somewhat since then many clients are still wary about financials away from covered bonds.EUROWEEK: Roger, to your point about the ratings downgrades being largely finished with now, what about on the hybrid side? Does that extend to the subordinated side as well, do you think, or are we talking more about senior debt? Doig, Schroders: Well, I was talking about senior debt, in that context. On the hybrid side, I guess, the majority of hybrids are now sub-investment grade, there aren’t that many left outstanding. I’m not sure that the market significantly differentiates between a single-B and a B minus in the hybrid space, so it becomes less relevant if there are changes now, but as I say, the point which I was making was largely in relation to senior. EUROWEEK: And with those downgrades, for some banks now to be issuing, are they going to need to see mandate changes on the investor side? Doig, Schroders: In senior, unless the indices change, investors aren’t going to change their mandates.Grodzki, L&G: If anything, what we have experienced over the past two years is mandates being changed to the disadvantage of the banking sector, i.e., possibly in rare cases ruling out financial non-senior or non-secured altogether. So at the moment I’m not quite expecting mandates to be re-adjusted in favour of financial bonds. I think it may be a little too early for that, given the financial sector still is still having to go through quite a bit of restructuring, even in the UK. For example the separation of commercial and investment banking is still an agenda item for many governments, and hence investors are unlikely for now to pull out all stops to have more room for investments in financials.EUROWEEK: Those mandate changes that you were referring to are not ratings-based mandate changes, but rather just a change to move away from senior unsecured?Grodzki, L&G: From hybrid, from subordinated, and sometimes even from senior. EUROWEEK: On the hybrid side, OK, there’s not a big difference between a single-B and a B minus rated issue perhaps. But with those instruments now in sub-investment grade, does that make it trickier to be able to invest in them? Or does it offer you more opportunities because there are less investors in the market taking up those types of instruments? Grodzki, L&G:I can only speak for LGIM. We are predominantly an investment grade investor. In our view the future of these bonds is in private banking, retail banking and high yield funds. Montague, ECM: We accept investment grade mandates, and clearly we can’t really invest in hybrids. Other mandates are unconstrained and can invest in hybrids and will continue to invest. EUROWEEK: And with those ratings going below investment grade, do you think there are more opportunities now, because there are less of the traditional FIG investors that can buy them?Montague, ECM: Yes, it certainly cheapens the market from our perspective. The other issue with a lot of these bonds is that they’ve been bought back. The issue size is now a lot smaller, a lot less liquid, and as a result the bid-offer spreads are wider. So when you buy these bonds, you’ve got a specific target in mind, they are not ones to flip. You have at least a medium term horizon, or an event’s going to happen, because the trend is that the bid-offers are at several points now, rather than one point. EUROWEEK: Interesting that you point to the liquidity side of things there. Obviously in the hybrid and subordinated spaces it’s a different ball game, but on the senior side, how are you guys seeing liquidity in the market at the moment? Is it there when you want to exit senior unsecured debt? You’re smiling, Roger. Doig, Schroders:I think recently nobody’s wanted to exit, so it has been quite limited, but mainly for positive reasons, I guess. Montague, ECM:I think probably Georg deals in larger sizes. We tend to do much smaller lot sizes, so we can get most of it done. But even I think anything above €5m or €10m can be quite difficult. Fong, Natixis: I would agree. Around €5m-€10m on a senior deal, given a name without any particular sort of issues on it, it is possible in a reasonable market. On the secondary side, anything north of €30m-€40m could potentially be — I wouldn’t say impossible to get those done, but I think you have to work a little bit more, rather than just being able to get an outright bid on €50m or so. The dealer community, as well as the investor base, their opinions on liquidity can change very, very quickly.

Since the start of August there’s been quite a bit of buying appetite, but dealers have run their inventories down over the summer months. In terms of running a large inventory, there just isn’t the capacity on the Street to do that very much any more, given the regulations that are coming through. In answer to your question, secondary liquidity is patchy, but I think €5m-€10m, you can probably get that generally done, reasonably easily.

EUROWEEK: How have you seen liquidity evolve, this year, in the senior market? Grodzki, L&G: Maybe compared to 12 months ago, it’s a touch better. We still see dealers keeping inventory levels tight, being themselves, of course, closely scrutinised by their regulators and, if anything, encouraged to scale back their trading books. But at the same time, if one factors in the rating deterioration which has happened, and of course the contagion from the sovereign side, liquidity could have deteriorated dramatically over the past 12 months, as many bonds were downgraded below critical thresholds. So one could say we’ve escaped by the skin of our teeth. Given where sovereign ratings are now compared to a year ago, given where bank ratings are compared to a year ago, it is a bit of a relief that things have been holding up OK. And, adjusted for ratings, liquidity may even have improved even a little. EUROWEEK: Roger, obviously you work with MTS and secondary liquidity is an issue there. What are you doing in that area? Roger Barton, MTS: A lot of buy-side and sell-side customers that MTS works with make the comment, that liquidity in the bond space is not good. Aside from the fundamental trading interest we’ve spoken about, the comment made is that even where there is trading interest the market landscape has changed and existing trading models no longer bring together trading interest to maximise available liquidity. This is partly as a result of reductions in inventory sizes, and changes in regulations and there’s a desire to explore alternative models as to how liquidity can best be provided to satisfy the trading interest.

I don’t think there’s any firm answers at this stage, but I think there’s a willingness from all sides to explore different potential models.

EUROWEEK: Are there any models that are particularly interesting at the moment? Barton, MTS: MTS has launched a "Prime" model whereby customers are able to access the trading platform through their prime dealer, and that seems to be gaining some interest with both buy-side and sell-side customers. Indications are positive but I wouldn’t say that the MTS Prime model is the only possible solution. I think there’s a number of solutions being explored.EUROWEEK: For the investors here, are you interested in looking at alternative models for generating liquidity in that sense? Is it a big enough problem for you to be thinking about alternative ways of looking at liquidity in the secondary market at the moment? Doig, Schroders: I think it’s the nature of the beast. Bond investment, fixed income investment, is always going to be illiquid in secondary markets, and you’re going to have very little in the way of two-way markets available. That’s particularly the case when you’re buying instruments with significant optionality. And I would say that part of the reason for shying away from that and asking for more plain vanilla-type instruments from issuers is precisely that you’re trying to avoid situations where that optionality is a liquidity killer that prevents people from trading, or makes the clearing price very substantially below or above where the instrument can be marked in your books.

We have seen a trend over the last year or so for issuers to issue more plain vanilla-type instruments. My guess is that that is at least partly driven by the fact that liquidity is a lot weaker than it was a few years ago. And that’s going to be a permanent feature, going forward, which has implications for alternative tier one and other types of instruments which are strewn with options which carry very significant risks, particularly if your portfolio is marked to market.

EUROWEEK: Robert, you were saying that anything above €5m-€10m can be difficult to sell. Does that change the way you behave in the primary market? Do you look at things more cautiously as a result of the illiquidity that we’ve seen? It’s a feature of fixed income markets, but it’s been a bit more pronounced the last couple of years. Montague, ECM: I think it’s probably more of a problem for L&G, or Schroders, than us. But clearly, we sometimes might put in orders of €30m or €40m, and we are aware of the particular bond we’re looking at, that there has to be an exit. Clearly in these types of markets, it’s quite difficult. So we do take that into account. Grodzki, L&G: We have had to change our tack and tactics, as the markets evolved over this year. There has been a sequence of risk-on and risk-off phases, feeding frenzies followed by paralysis. One had to be very nimble in the primary market in order not to miss out on the opportunities if and when they arose. I wouldn’t want to generalise and profess that we have pursued a single strategy this year.

We try to be fair in new issue conversations, i.e. we try not to overstate our genuine interest. And we hope that the market will move away from the exaggerations with order books well in excess of issue size, but later performance not quite squaring up to the initial hype, and therefore leaving doubts about the quality of the orders. Hopefully the market will find an equilibrium where things will normalise.

EUROWEEK: Roger, incoming regulation on trade execution transparency — what’s going on there, and how is that going to affect liquidity in the secondary market? Barton, MTS: Well, we don’t yet know how the details of the European regulation are going to turn out. But I think we can see fairly clearly the main strands. Firstly, fixed income is being brought within the MiFiD regime, which means that there’s going to be a requirement for increased levels of transparency in both pre-trade and post-trade. There’s going to be an extension of the regulation of the trading venues, the platforms on which fixed income is traded.

And while the regulations don’t mandate the use of electronic platforms, they are clearly going to have the effect of reinforcing the trend towards electronic trading. Electronic platforms are considered to be more capable, to achieve the requirements of the regulations including transparency requirements.

And those are the main strands of the regulation. The danger of course is, particularly on the transparency side, that the regulators overcook the transparency requirements, which could impact liquidity. The indications are, so far, that the regulators are being careful about that. But as I say, we don’t know the details of the regulations. There seems to be a recognition that, for example, the bond markets work in a different way than the equities markets.

So we have to hope that the worst excesses are avoided. But clearly, there will be a tendency towards greater transparency, greater regulation of venues, and increased electronic trading.

EUROWEEK: And the higher requirements around transparency, is it going to slow things down, and perhaps limit the liquidity in the market, do you think? Or is it really too early to say what the affect is going to be on liquidity? Barton, MTS: A lot will depend on what they call the calibration, how granular the trading needs to be, and how quickly the reporting needs to happen, and what the waivers are. Clearly there needs to be waivers for large transactions. Clearly there needs to be a suitable regime for less liquid markets. And the key point is to ensure that the calibration of the transparency requirements, for example, in the bond markets, are taking into account the characteristics of the bond market."One size fits all" is not the answer.EUROWEEK: As it stands, it seems like the regulators are understanding that it’s a different type of market that functions in a different way? Barton, MTS: They appear to understand that. The proof of the pudding will come when we see the details of the regulations and proposed calibrations. EUROWEEK: Regulations are everywhere at the moment, so I might use that as a point to segue onto the bail-in framework, the crisis management directive which is in the draft stages at the moment. How has this changed your outlook on senior unsecured paper, and covered bonds? Has it made covered bonds more attractive, does it just shift the risk/reward a little bit? Grodzki, L&G: Everybody in the market has been occupied with the word bail-in now for over two years. So we’ve had some time to understand the implications. Still I’m not sure yet we are fully comfortable with it. But we note that regulators seem more willing now than maybe in the early stages of this discussion to appreciate the second order effects, which well intended new regulations can have on the banking system. Those second order effects can be counter-intuitive. We feel encouraged that the quality of the dialogue between the market, and I mean investors here, and regulators, has improved.

Therefore we are somewhat less concerned that a badly or overly harshly worded bail-in framework would undermine the business model of banks and create new cliff risks, which is exactly what we should avoid. So we’ll see. The market’s and our initial response was to focus on non-bail-inable debt. Now there is some re-balancing taking place, which incorporates the assumption that regulators will be sensible when using this tool, and will be aware of its impact on investor confidence if and when it is used.

EUROWEEK: When you say the focus is on non-bail-inable debt, are you talking about covered bonds, or are you talking about senior unsecured with a shorter maturity? Grodzki, L&G: Well, covered bonds first and foremost. But you’re absolutely right, short-dated senior debt is another area where one could diversify away from bail-inable debt. Montague, ECM: It’s interesting, there’s been a bit of issuance with maturity dates post-2018, people don’t seem to have blinked an eyelid at buying that, which I find interesting. I think some of the French names have done that. Fong, Natixis: Yes, we executed several issues for French issuers recently, and we did not see any impact on the pricing or on the demand for deals longer than 2017. Montague, ECM: It’s quite interesting. EUROWEEK: Is it something that you factor in already when you’re doing your credit work? Has the curve repriced beyond 2018 to factor that in? Is it a simple matter of looking at the reference points now, or when you look at, say, a new 10 year, do you have that as something else that you take into consideration? Montague, ECM: I’ve certainly mentally repriced it. As to how much it’s worth, it keeps on moving, it depends on the market’s risk appetite at the time. But it’s worth in senior at least 50bp-60bp, at this moment in time, I’d say.EUROWEEK: Depending on the borrower?Montague, ECM: Yes.EUROWEEK: Roger, how has the publication of the crisis management directive changed the way you analyse senior unsecured and covered bonds? Doig, Schroders: Like Georg, we were quite pleased when we read the draft that some of the key points, particularly the focus on maintaining hierarchy of the capital structure, in the event that the tool was used, and also on ensuring that the language around when the trigger would actually be breached, was actually reasonably robust. It isn’t too discretionary on the part of the regulator, there does seem to be a clear intention that the test is that without this action the bank would otherwise have to go into insolvency proceedings. So there isn’t an undue change in the probability of default.

So seeing those laid out quite clearly, I think we took comfort that the engagement around that is better than it might have seemed in earlier drafts. We do think there is maybe a bit of a premium in the market for bail-in. But it’s not that significant beyond 2018. We’ve looked at different banks’ curves, and there doesn’t seem to be anything in Scandinavia or much in France. There might be a little bit in the UK, 25bp or something like that. But we can’t see a major kink in the curve because of bail-in.

Looking at bank spreads of countries with bail-in currently, like the UK, versus others, and bank spreads versus industrials, our view would be that the market probably systematically over-estimates the likelihood that bail-in will actually be triggered. It chooses to ignore some of the offsetting factors relating to Basel III which was the increase in equity and the increased regulatory intervention in banks at much earlier levels than would have otherwise been the case, well before the point of non-viability is reached.

And over time that means that there is a spread to be earned in financials which will reduce over time as people become more accepting of these mitigating factors. I guess the thing which offsets that, or which is causing people to be a bit reluctant to give credit for is, of course, in the deleveraging environment. It’s very difficult for most banks to actually generate capital organically. So there is a clear sense that a lot of banks in the eurozone are, and remain, subject to systemic shocks of one form or another, whatever they may be, and they don’t have significant organic capital generation potential to actually absorb those, should they come along.

Again, that’s something which over time should fade out.

So on the whole, we’re quite comfortable that the language that has come out in the draft is language which relates to a reasonably out of the money event, or one which is very similar to insolvency, that there isn’t excessive regulatory discretion in choosing when to put the bank into a crisis management programme. We’re comfortable that the hierarchy of the capital structure is to be maintained, and we think that over time that will get reflected in spreads which currently look, as I say, quite wide.

Grodzki, L&G: But much also depends on each individual bank’s balance sheet composition. There is a regulatory push to reduce the dependence on wholesale funding, which means less issuance in the future. It would also mean that if bail-in is ever activated, the possible lossgiven default would be higher, because there would be less non-secured senior wholesale debt which could be utilised. That assumes depositor preference, which is not the case in all countries. But we have to wait and see to what extent depositors will have to contribute in a bail-in scenario. Given the future proportions between deposits and senior unsecured debt, depositor preference will be an important swing factor in deciding how much extra risk bail-in will actually pose for senior unsecured debt
holders. Montague, ECM: Paradoxically, in some ways, it’s better to be a senior unsecured creditor in a commercial investment bank, rather than in the retail funded bank, because you’re behind depositors, whereas in an investment bank, the deposit base is a lot smaller. There’s a slight contradiction there. EUROWEEK: Does the amount of covered bond debt outstanding have a similar affect? Grodzki, L&G: Well, according to calculations I’ve seen a couple of months ago, the levels of asset encumbrance were rising over the past few years, and starting to become material. But, if I’m not mistaken, the average — if the average is meaningful at all — was somewhere between 15% and 20%. So in itself, that’s not yet posing a major threat, relative to the potential threat of a strictly applied depositor preference.EUROWEEK: There’s been talk on and off about some sort of bail-in buffer-type instrument which is not regulatory capital, but is subordinate to senior, that banks could issue to give senior unsecured investors a bit more comfort in the case of bail-in. What do you think about something like that? Do you think, first of all, would it serve a purpose? Once banks have these huge capital ratios, as they’re supposed to have under Basel III, will they need something extra like that on top to help reassure senior unsecured investors? Montague, ECM: Isn’t that what lower tier twos are meant for these days? EUROWEEK: I think the thought is that they’ve got their 2% lower tier two bucket and this would be something on top of that. Doig, Schroders: It’d be senior lower tier two. Technically it’s a buffer against senior unsecured. But it all presumes that 17% is the right level of loss absorbing capital. And there’s nothing set in stone about that. That’s a number which has been put forward. In theory, if you’ve got lots of instruments below you in that 17%, then you’re more secure than if it were 13% or 10% or whatever. So in theory, the senior unsecured layer of that, the highest layer above the 17%, would be at the margin, more secure. But it would still be subject to bail-in. And it would still be subject to not being pari passu with depositors. It would still be subordinated to covered bonds, and it would still be subordinated to repo.

So yes, it might help at the margin. But if you think that it’s going to have a material impact on your funding costs for senior unsecured, if you are issuing this instrument, then I guess that’s probably wrong.

Grodzki, L&G: One should also remember that we’re talking about risk-weighted capital ratios. There has been a lot of debate, and I don’t expect that to fade any time soon, about the wisdom of the risk-weighting system which is in place, whether it’s the standardised approach or the advanced approach. Take the example of the much discussed issue of the zero risk rating for sovereigns and the current risk weighting framework does not look prudent at all.

So, before getting carried away with improving and fine tuning risk-weighted capital ratios, and debating how much contingent buffer is appropriate, one should also then, from time to time, do a reality check and look at non-risk weighted capital ratios.

Montague, ECM: The European Commission are talking at about 10% of the liabilities, in bail-in debt. If you look at a thick cross-section of European banks, you’ll find probably their equity plus tier two, tier three, and so on, is probably at around seven, 8%, I think. Grodzki, L&G: Of total assets, unweighted.Montague, ECM: Yes. So obviously they need to make up a buffer to get them up to 10%. With the unsecured, a lot of them are well above that. Some are still just over. So actually there is room for some more bail-in instruments.EUROWEEK: Staying on the topic of bail-in, I’m interested in your thoughts on tier two in general. Obviously we’ve seen a few deals over the last few days. And talk about bail-in, or point of non-viability, has been a really big factor there in terms of how you reference this crisis management directive that’s coming out. Roger, from your point of view, does it matter whether the crisis management directive is referenced in the risk factors or the terms and conditions? Should we just assume that all tier two is going to be subject to bail-in in the future? Doig, Shroders: Well, yes. Crisis management imposes statutory bail-in conditions on qualifying tier two instruments. So, yes. Whether it’s got contractual recognition of it or not, in theory, it should participate in a bail-in should that come about. All English law, or European law bonds, will recognise that automatically. There may be some exceptions elsewhere.

But I think there is a sense in which it doesn’t matter until you go to a different jurisdiction, in which case you do need to have contractual recognition of the statutory bail-in framework, in order to know this is going to be affected. So we don’t think there should be a material difference in pricing of old-style tier two versus the recent issues which have explicit language recognising the point of non-viability.

EUROWEEK: Would you agree with that, Robert? Montague, ECM: By and large, although I think there’s been a lot of market participants who have been focusing on the differing language within the new bond documentation. We prefer the regulatory language which is referred to in the terms and conditions, or the risk factors. But as Roger says, ultimately both old-style and new-style bonds will be covered by a statutory bail-in framework. EUROWEEK: Is there an argument there, though, if it’s in the contract of the bond, then that’s sort of an additional...Montague, ECM: Safeguard? EUROWEEK: Safeguard, perhaps, or risk?Doig, Schroders: The trigger of loss is still the same. Montague, ECM: In terms of the new-style bonds, the most recent issues done didn’t have substitution and variation language in there, because investors were concerned that it gave the issuers too much optionality. EUROWEEK: Let’s move on to additional tier one. It’s still a bit of an evolving field, but there’s more talk now of temporary writedown versus permanent writedown. I understand there’s some mandates out there, there are some banks looking at printing this kind of stuff. What structures would you be willing to consider buying of the new additional tier one instruments? Grodzki, L&G: I can keep that one short. From our perspective, we’re probably at the orthodox end of the scale, and insisting on the hierarchy of capital being respected, which to us means there can’t be any permanent writedown as long as equity holders have not been written off completely. Conversely if shareholders can recover some of their their losses through share price appreciation, debt holders should have their claims written back. Otherwise the capital structure would be turned on its head. Hence no writedown should be permanent as long as there’s a chance of the bank rebuilding itself and shareholders at least partly recovering their losses. We hope that this will be reflected in the future draft templates from the regulators on eligible tier one. Doig, Schroders: But it’s also a complete red herring. Any bank which breaches the 5.125% core tier one ratio is going to have reached a point of non-viability, and so there’ll be a permanent writedown. So the idea that their temporary write-up makes it more palatable, it’s just nonsense. It could be the case if your trigger level were then set at a much higher level, but then there are other reasons why you wouldn’t buy it. So it’s a discussion structurers have, I think, probably in an ivory tower. In practice, it doesn’t seem to us that there’s a viable market for this kind of instrument. Grodzki, L&G: Absolutely. And you mentioned earlier, the ratings themselves, at the moment, would make it — permanent or temporary writedown — pretty much impossible to invest in any meaningful size.Montague, ECM: Assuming they were rated, as well. Grodzki, L&G: Absolutely. If they are rateable, and if they are rated. Not everything which is rated is rateable. The agencies sometimes take it too far. Doig, Schroders: The fundamental problem with them is not necessarily writedown language. It’s the fact that the coupons are entirely discretionary. And so if you’ve got a shareholder-owned bank, you’ve got a complete conflict of interest. In the end, you invest in a bond because a bond has a contractual obligation to pay a certain amount at a certain time. If neither of those apply, it is not a bond. And so bondholders shouldn’t be buying them. And won’t buy them.

You’ll find that they are sold into markets where either there is a lack of understanding of what people are buying, or they are sold to investors who are going to be very pro-cyclical in terms of their appetite for buying and holding these instruments. But there isn’t a bond investor base for these instruments, as far as I can see.

EUROWEEK: Robert, do you agree with that?Montague, ECM: I’m slightly more heretical than my colleagues there. We are open to all instruments. We do propound the view that, with these instruments, you have to find a new investor base. The traditional fixed income investors aren’t comfortable with them. It’s almost like a new asset category, a bit like high yield. Because traditional high yield themselves aren’t particularly interested in these either. These are high yield guys from a corporate background, who don’t understand banks, don’t understand the structures, it doesn’t really interest them. They want them excluded from the indices if possible.

So I think you have to find a new investor base out there. And I think there’s room in a portfolio for this type of instrument, if it’s priced correctly.

Grodzki, L&G: What about shareholders being the main investor base? Because with the exception of voting rights, these are shares in all but name. Doig, Schroders: Why would you ever pay par for one of these instruments? Montague, ECM: It comes down to pricing, I agree. I think there is an investor base out there, a sophisticated investor base. But it’s very much in its nascency.EUROWEEK: The debate on permanent versus temporary has come around because there’s a view that fixed income investors are unwilling to buy the securities that will convert into shares at a given trigger point. Is that fair, or do you think that ultimately the incentives are better aligned? Doig, Schroders: Well, in principle you’re correct, but for the reasons of non-viability language, etc, which I mentioned before, it’s a complete irrelevance.

The incentive to believe that there might be a fixed income base out there is because the tier one hybrid market developed with a fixed income base. But these instruments were rated two notches lower than high investment grade rated things, and at that point in time, yes, maybe it worked. Sure.

But the point in time they’re trying to launch these is completely different, and you don’t have any of these advantages.

You have an investor base which, because of some of the liquidity issues that you talked about, certainly if you were buying anything in any size, you need to avoid having any optionality in the instrument, any significant optionality in the instrument, in order to at least have the prospect of a little bit of liquidity should you need to exit the position in time. And as a result, the appetite for buying anything which is not plain vanilla is markedly reduced. So the bid-offer in the secondary market is much greater, the liquidity in the instruments, if you do own them, is much worse.

The drawdowns which you get in your funds, if you own them, and we go into a difficult stage, the drawdowns can be huge. And you rely on, or you hope that the issuer provides liquidity for you. But you often have to have lost a lot of money in order to take it to that.

So I think the chance of actively getting these into a mainstream bondholder investor base is very limited. Getting into high yield I think is extremely limited as well, because they have plenty of choice in bonds. They don’t need to have preference shares to get these kinds of returns.

And so you end up with an investor base which is in awe of the issuer, or feels that they have some kind of influence with the issuer, rather than an investor base which is a sort of institutional one.
  • 02 Oct 2012

Bookrunners of Global Covered Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 25 Oct 2016
1 UBS 11,498.67 72 6.01%
2 HSBC 10,710.61 60 5.60%
3 BNP Paribas 9,831.12 47 5.14%
4 Credit Agricole CIB 9,513.58 45 4.97%
5 Commerzbank Group 9,052.55 54 4.73%

Bookrunners of Global FIG

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 24 Oct 2016
1 JPMorgan 83,632.79 365 6.90%
2 Citi 78,369.17 439 6.46%
3 Morgan Stanley 71,293.89 310 5.88%
4 Goldman Sachs 68,728.80 354 5.67%
5 Bank of America Merrill Lynch 67,654.98 332 5.58%

Bookrunners of Dollar Denominated FIG

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 25 Oct 2016
1 JPMorgan 66,103.08 263 10.70%
2 Citi 63,508.84 343 10.28%
3 Bank of America Merrill Lynch 56,965.71 282 9.22%
4 Morgan Stanley 50,049.01 235 8.10%
5 Wells Fargo Securities 47,073.69 227 7.62%

Bookrunners of Euro Denominated Covered Bond Above €500m

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 25 Oct 2016
1 Credit Agricole CIB 8,094.29 29 8.17%
2 BNP Paribas 7,155.53 27 7.22%
3 UBS 6,774.88 24 6.84%
4 UniCredit 5,793.45 23 5.85%
5 LBBW 5,728.28 22 5.78%

Global FIG Revenue

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 02 May 2016
1 Morgan Stanley 365.83 497 7.62%
2 JPMorgan 332.66 618 6.92%
3 Bank of America Merrill Lynch 299.89 590 6.24%
4 Goldman Sachs 276.71 375 5.76%
5 Citi 264.54 592 5.51%

Bookrunners of European Subordinated FIG

Rank Lead Manager Amount €m No of issues Share %
  • Last updated
  • 25 Oct 2016
1 BNP Paribas 6,662.83 23 9.67%
2 UBS 6,524.55 26 9.47%
3 HSBC 6,275.95 20 9.11%
4 Barclays 5,522.64 16 8.02%
5 Citi 4,577.05 23 6.65%