The importance of retail investors is set to grow. It may not herald the return of the very structured products of pre-crisis days but the cheap and abundant funding retail investors offer banks mean that they will become something of a support line if wholesale markets continue to tread warily.
"If institutional markets remain shut for many borrowers, retail markets will naturally offer an attractive source of funding," says David Carmalt, a managing director in financial institution debt capital markets, at Lloyds Bank Corporate Markets. "It is unlikely that it will grow to offer a meaningful percentage of the larger borrowers funding needs, but as treasury teams focus on investor as well as currency diversification, we would expect that it becomes an area more borrowers focus on."
The European sovereign crisis in particular has made the wholesale funding gap more uncertain and has made the retail side more interesting to issuers.
The diversification into retail funding offers various alternatives. Retail investors can be divided into three categories: those wealthy enough to invest through private banks and those that either leave cash on deposit or buy securities sold through branches or through financial adviser networks.
Each group favours particular products and offers particular funding opportunities but there are things that all have in common. First, they offer a diversification of funding sources away from wholesale bond markets. Second, they force banks to offer a broader mix of funding types by demanding a variety of different instruments and products. Third, they offer relatively cheap funding.
"The retail funding base is of utmost importance and will become of even greater importance," says Carsten Offermann, head of the banks team within UniCredits financial institutions group.
Deposits the regulators favourite
It is growth in deposits that some bankers have noted in particular within the retail sphere. Much of that push from banks for deposits is because of the favourable treatment they receive under Basel III. Both the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) look upon retail deposits as solid capital.
The overall run-off rates the amount presumed to be redeemed without then being reinvested is between 5% and 10% for retail deposits compared to 25%-75% for unsecured wholesale funding under the LCR. Meanwhile, banks can count 80%-90% of their retail deposits towards their NSFR compared to 50% of large corporate deposits with maturities of less than one year, say.
Banks have encouraged deposit growth but there has also been an increase in demand due to the uncertainty that troubles markets in general. "There has been a natural increase in demand for deposits," says Kris Devos, global head of debt syndicate at ING. "People are keeping their cash close to their chests in these uncertain times but banks have been aggressive in pricing them too."
However, the infrastructure of a deposit programme is difficult to put in place, say bankers. Even Deutsche Bank found it preferable to buy Postbank, say bankers, than develop its own retail investor base further. Nordic and French banks in particular are those now putting the most effort into developing retail deposit bases.
The appetite for highly structured retail targeted bonds has greatly diminished in recent years. Interest remains in vanilla or lightly structured rates products such as capped or collared floating rate notes rather than more complex pay-offs. Different segments of the retail investor base have different appetites for certain products, however, and the appetite to sell various products to each audience also varies.
"There is an important difference between genuine retail and high net worth investors, not just in terms of the channels you access but also for product stability," says Christoffer Mollenbach, head of financial institutions DCM at Lloyds Bank Corporate Markets. "You want to be sure the products you market through these channels are suitable for the investors that have them. You dont want to sell complex structures to retail investors. Theres a lot of effort into making sure the corporate governance and compliance is right."
But it is not just the complexity of a product that makes it appropriate for a given audience. Retail investors, on the whole, focus on the borrowers name that they are being offered. "Investors pay a lot of attention to a borrowers jurisdiction looking for banks from so-called safer countries," says Offermann.
High net worth and private banking audiences remain a channel for structured products, however. The investor base that once fuelled so much of the MTN market may not be as active as it was before the credit crisis but they are still a source of funding for banks willing to offer tailor-made products across a number of smaller tickets.
Such investors demand combinations of a strong name and a high coupon, which pushes them into more structured territory.
With the appetite for structured senior unsecured products subdued for a number of years, the new breed of bank capital instruments, including contingent capital bonds (Cocos) are a new area of focus.
"Retail investors are looking for Cocos like the Credit Suisse and Rabobank deals which presented interesting coupons for strong names," says Philippe Hombert, global head of FIG DCM at Natixis. "Historically these investors have been interested in corporate bonds, but if bank borrowers can pay a 4.5%-5% coupon, they could attract private banking retail clients."
The Asian market is one such region where banks are targeting capital product sales and it is one of a few groups of retail buyers open to non-domestic names. The focus on high coupons remains even if the appetite for structures has not, which could lead to Asia being a good outlet for bank capital products.
Asian private banks have been particularly keen to look at the product. In Rabobanks 2bn Coco deal in January, private banks took 79% of the bonds. Asian accounts took 51% and the Swiss, 17%. Private banks took a third of Credit Suisses 2bn Coco deal issued in the same month.
But it is not just the wealthier end of the retail investor base that has an interest in bank capital instruments. Bankers report secondary market buying in particular of subordinated bonds as investors hunt for high coupons. "If you look at retail markets away from deposits, you are often selling coupon levels," says Leo Greve, head of origination at ING.
That is just as well, since the institutional market is not just shunning senior unsecured paper at the moment. Bank issuers and retail investors stand at something of a tipping point over whether or not the latter will provide bank capital funding in the post-Lehman world. "A lot of institutional investors are not in favour of Cocos," says Greve.
"You might have to look to see if retail markets could be an outlet for them given the higher coupon level. Then you have to ask if retail investors should be buying Cocos because of the extra equity downside risk involved. The retail market will not compensate fully for institutional demand but there may be a role for retail to play in capital products."
The volumes achievable may not be extravagant in terms of the overall funding targets for big banks but retail buying of capital instruments can make a healthy contribution to a banks coffers.
"For branch retail customers, senior unsecured and lower tier two products are interesting," says Hombert. "Retail investors in a banks own network can be worth 10%-20% of funding."
The most obvious and likely source of retail funding to banks is in their home market, where name recognition is highest. However, not all banks have developed domestic retail markets for bonds, while some non-domestic markets have also provided funding for banks facing difficulty accessing wholesale markets.
Italy is one such market that has allowed banks such as Royal Bank of Scotland to raise retail-targeted issues. "Italian banks are proposing to other issuers to participate in their own retail investor networks," says Hombert. "This will extend to other developed retail markets too it is a global approach. Barclays and RBS use the Italian retail market extensively, for example," says one senior FIG banker. "Name recognition is important but they will sell through domestic banks retail branch networks."
Currency diversification is also a focus for bank treasuries with Canadian, Australian and New Zealand dollars important for European borrowers and investors.
One market that is slowly grinding into motion for genuine retail bonds is in the UK. Royal Bank of Scotland has issued Royal Bonds in recent times a departure from the retail products called bonds but that are really deposit accounts with withdrawal restrictions more typical of the UK market.
"The demand is for plain vanilla fixed rate bonds and they are key to developing the market," says Mollenbach. "Some banks have tried inflation-linked products which seemed to make sense but havent gone down too well."
The London Stock Exchange is busy building the UKs retail bond market through its Order book for Retail Bonds (Orb). It has organised roadshows to promote the market to independent financial advisers and banks like Lloyds say they are committing resources.
"Were spending a fair amount of resources on it," says Mollenbach. "We think it has potential and will be self-perpetuating. The more deals there are, the more investors will look to enter the market."Lloyds move of developing its domestic retail market before looking overseas is typical of banks throughout Europe. The second step, especially for European banks, is to access those retail markets in their region open to foreign credits such as Italy.