Conditions in the second half have been exceptionally volatile, with the the senior market swinging from suicidal pessimism one day to cautious optimism the next. However instead of getting better in September, as many hoped before the summer holidays, the mood turned markedly worse. Even the most upbeat syndicate bankers have begun to admit defeat.
The iTraxx senior financials index, a measure of CDS prices and a key indicator of market sentiment, hit a new record high on September 12, 320.5bp, against 121bp on April 6.
And although many issuers are well funded after front-loading in the first half of the year, meaning they can ride out the storm for a little longer, the volatility created by the eurozone crisis masks longer term concerns about the market and the future of senior debt as an asset class.
But first and foremost in market participants minds is pricing and execution risk. Secondary market spreads and CDS for senior FIG bonds have risen steadily since worries about Greeces finances resurfaced in April, and optimism has become scarce on FIG syndicate desks.
"Theres no real light at the end of the tunnel," says Christian Mundt, syndicate manager at DZ Bank. "Covered bonds have picked up but Im not convinced we will see any meaningful senior issuance. I am not aware of any imminent senior projects, and the only issuers I can imagine doing anything right now are the big national champions. They do self-led transactions and can therefore react very quickly on market opportunities."
Such high spreads in the secondary market not only make primary issuance unappealing but the volatility also increases execution risk, as Mundt explains.
"Its very hard to find reasonable levels for new issues when secondary markets are as illiquid as they are at the moment," he says. "Spreads in secondary markets are not determined by volume at the moment, its traders protecting themselves and of course investors who are not willing to buy or sell on the current spreads. It has almost come to a complete halt."
Tempting as cash spreads may be right now investors could pick up a juicy return if they were to buy just before spreads contracted the risk is just too high for most buyers. And even for issuers that are well recognised enough to execute a deal, it just isnt worth it at such high levels. Consequently, for issuers with the resources to tap the covered bond market, senior has become less of a priority.
"When the spread differential of senior unsecured versus covered bonds is low, the funding incentive is swayed more towards the senior market," says Caroline Bryant, head of FIG DCM for Nordics and Netherlands at Natixis. "But when that differential is wide, senior funding is less attractive. As such, senior funding has become in some cases more of a secondary or rather complementary funding tool for banks, but for large banks it is still very important, as for smaller regional issuers which have not got collateral capacity to set up a euro covered bond programme."
Many issuers especially those sitting pretty on plenty of cash after storming the markets in the first half of the year have also expressed intentions to fulfil their remaining funding quotas in the private placement market.
"We are monitoring the senior market but we dont have any particular need to come, as weve more or less fulfilled our funding requirement," says Morten Vagno, head of debt investor relations at Nykredit. "We are in no need of a benchmark were tapping the private placement market. If the senior market stays difficult and doesnt open its not really a problem for us."
However, for smaller banks, especially those from peripheral jurisdictions although even stalwarts of the senior unsecured market, such as BNP Paribas and Société Générale have not been spared in the recent volatility the lack of access to the senior market is more pressing. Several Italian issuers recently expressed concern that a lack of new mortgage origination meant they could not continue tapping the covered bond market at the rate they had been, and for many, prices in the senior market do not make for attractive margins.
But bankers emphasise that this does not constitute a funding crisis yet.
"In the short term, I cannot believe for one second the authorities will make the same mistakes they made in 2007 and 2008," says Andy Young, head of FIG syndicate at Credit Suisse in London. "They may make different mistakes but not the same ones again. If necessary, they will flood the market with liquidity. Banks will be able to fund themselves. It may be on a short term basis through the ECB or the Fed window, for example but the authorities will go to great lengths to provide that liquidity.
"If there isnt access to senior and covered in September, youre going to see the size of the ECB and Fed balance sheets increase and youll see the funding duration for banks continue to shorten."
While the eurozones troubles have dominated markets in recent months, they have eclipsed equally important issues concerning tough regulations and the spectre of the senior bail-in. If and when the volatility subsides, many investors may start to look more closely at senior unsecured as an asset class.
Many market participants believe regulators should be doing more to combat investors concerns about senior unsecured investments, especially after recent volatility in bank shares and worries over both the short and long term bank funding markets, particularly for European institutions.
The European Commission is due to release a paper on bail-ins and resolution regimes in the coming months, but bankers say the issue is more pressing than that.
"As soon as the eurozone debt crisis stabilises, people will focus on bail-ins again, and that issue is not even close to being finalised," says Mundt. "As long as there is no real clarity around this topic, investors will remain very hesitant when it comes to senior unsecured debt issued by banks. Sooner or later this is going to become a problem as there is already funding pressure on FIG issuers in senior as banks cannot issue unlimited volumes of covered bonds."
Syndicate officials say banks are investing less in senior unsecured bank debt, and the market is relying more on asset managers. Thats fine, so long as asset managers are happy to continue buying. But are they? Once again, a lack of certainty is letting the market down.
In defence of senior, some syndicate bankers point to grandfathering meaning any changes in the treatment of senior under a resolution regime would be phased in gradually and would not affect existing liabilities. But a Financial Stability Board paper in July suggested bail-in powers should be applicable restrospectively, and many investors feel this has set a precedent.
"It would definitely be encouraging if existing debt were grandfathered but the idea of bailing in existing debt is out there now," explains Caroline McQueston, a financials analyst at Bluebay Asset Management. "We think sub debt would definitely get a haircut if needed, and the worst case scenario is that even if senior were grandfathered it could still be haircut under some sort of extraordinary legislation."
However, not everything about the market is negative. The banking sector was thrown a bone recently when politicians said the speedy implementation of regulations could spook the markets, suggesting the process should be postponed until stability returns.
Purely in terms of demand, the relative value of senior FIG debt compared to other sectors could be a boon to the banks. "Many credit investors still need yield, so there is definitely room for the senior market," says Cedric Perrier, FIG and covered bond syndicate at Natixis.
"One thing supporting the demand for senior unsecured paper is that pretty much since the crisis, senior banks spreads are a lot more attractive than corporate spreads," adds Bryant. "In a context where corporates generate limited issuance, being for the moment either cash-rich or having access to a more attractive loan market, financials offer good value."
One thing is for sure: the next few months will be a bumpy ride. The eurozone saga has many more months to run, and without real clarity on what a sovereign default would do to banks spreads are unlikely to come in and investors are unlikely to start buying.However, senior still occupies an important place on issuers balance sheets and something has to give. Issuers, syndicate bankers and investors must hope that Europes sovereigns dont spoil the party. Otherwise, a long summer may turn into a very, very long winter.