As benchmark transactions go, the government guaranteed Eu3bn three year transaction from Barclays Bank in October was one of the most anticipated bond issues of recent years. Bo
Failure was simply not an option. The deal would set the tone for an entire asset class and getting it wrong would mean that yet another funding avenue for banks would be shut. The latter was simply not worth considering as, since the failure of Lehman Brothers in September, other funding routes had been shut to bank borrowers.
Furthermore, the success of the Barclays deal was crucial given that, while the UK was the first jurisdiction to see issuance of this kind, other Europeans were set to follow in the coming weeks and months.
The transaction came on the back of unprecedented measures taken by the UK government to shore up its banking system. As part of a £500bn rescue package, the government said it would recapitalise banks but it would also provide them with a guarantee for £250bn worth of senior bond issuance with maturities up to three years.
In fact, the UK was not the first to make this kind of offer.
At the beginning of October, Ireland had issued a blanket guarantee for its whole banking system covering deposits and liabilities including subordinated debt, but was still in the process of passing it into law. At the time, the measures had generated criticism some deemed the action to be uncompetitive that ran contrary to the case-by-case intervention other governments had been using.
However, Ireland turned out to be the forerunner and since then, almost every government in the world has issued bank guarantees in a variety of shapes, forms and sizes.
As the trailblazer for the new asset class, Barclays could not afford to see its deal fail. In the end, careful timing and sounding of investors meant that the transaction was a resounding success.
The order book of over Eu4bn defied many expectations and gave confidence that government guaranteed debt was an attractive product for both issuers and investors.
UK leads the charge
"As an issuer, Barclays Bank was keen to show leadership and to be among the first issuers of this product thereby establishing a liquid benchmark and pricing reference for this new asset class," said Mark Geller, head of FIG syndicate at Barclays in London at the time.
"There was an element of discovery to the deal but we worked very hard with different groups of investors including central banks, rates buyers, bank treasuries and credit investors to understand their views of the product and their appetite generally to buying it in a range of currencies, formats and maturities."
Given the success of the deal, it did not take long for other issuers to follow.
Following Barclays, Bank of Scotland priced the first dual tranche guaranteed exercise, a £600m three year and a Eu3bn two year.
It was clear from this second issue that demand was growing as investors became more comfortable with the asset class and were either joined by other investors or were increasing the size of their orders. Indeed, the tranches attracted £1.3bn and Eu4.5bn of orders respectively.
The orderly queue continued and Royal Bank of Scotland was next up, raising Eu2bn and £1.4bn in three year format in the first week of November. Again, there was no doubting the strength of demand as Eu8bn and £4.5bn poured in for each tranche.
Lloyds TSB Bank and Nationwide followed, again attracting large order books and adding further reference points to the UK curve with success.
"The asset class has established itself and penetration within the rate buyers universe continues to increase, providing bank issuers with access to investors away from the traditional senior debt buying base," says Adam Bothamley, head of FIG syndicate at HSBC in London.
"With each new deal, we are seeing time to market decrease and liquidity within the sector increase while pricing for issuers continues to improve."
While the UK banks were first to arrive at the party, banks in other jurisdictions have since followed. Most have opted for a UK style approach, which sees banks borrow in their own names.
As this report was going to press, Allied Irish Banks was the latest addition to the government guaranteed bank debt curve, having priced a Eu2bn September 2010 deal via Deutsche Bank, HSBC and Société Générale. Once again, there was no doubting the strength of demand which reached Eu3.9bn by the time the leads closed the books.
Pricing improves for SFEF
The deal for AIB was the widest print to date for a government guaranteed issuer at 55bp over mid-swaps and reflected the fact that as a sovereign, Ireland trades around 100bp back of the UK on a credit default swaps basis. Therefore, its pricing had to offer a premium to where UK guaranteed debt was pricing.
Furthermore, the leads had to take into account the fact that Ireland had priced a Eu4bn three year at 25bp over mid-swaps in October. Recently it has been popular to use sovereigns CDS as a key reference point for pricing new bonds. However, going forward, it is hoped that there will be enough liquidity in the asset class for issues to be priced against secondaries.
"The perception is that these assets have performed on the break and that has helped the asset class," says Aubrey Simpson-Orlebar, head of syndicate at Lloyds TSB in London.
"What has helped performance is the fact that orders havent come on the back of switches but on the back of real money demand. It is real cash that has been put to work in these issues."
AIB and other Irish banks will be hoping to see a similar performance to that seen from UK guaranteed bank paper, allowing them to price their deals tighter. In the UK, since the Barclays deal priced at 25bp over mid-swaps, spreads have come in sharply.
The last two UK bank deals to come to market, which were both taps of outstanding deals from RBS and Nationwide, were priced at 15bp over mid-swaps.
"For the time being, supply has been well absorbed and pricing has been getting tighter which shows that different jurisdictions can co-exist," says HSBCs Bothamley. "The approach taken so far by issuers which has been quite co-ordinated has meant that there has not been the impression of oversupply, which has been a key element to performance. As more jurisdictions come online however, the clear challenge will be how everything can co-exist together and how issuers access what is a finite pool of liquidity."
While it is clear that intra-country issuance has been co-ordinated and has followed a gentlemens agreement with banks issuing in an orderly manner, it is far from sure what will happen inter-country.
As regards the strength of demand, as shown recently with AIBs Eu2bn deal, it was possible for both RBS and Nationwide to find strong demand for their increases in the same week.
Furthermore, RBS launched its guaranteed deal in the same week as Société de Financement de lEconomie Française (SFEF) priced its inaugural transaction for the French banks.
Unlike the UK system, the French format is to issue guaranteed bank debt through a vehicle with the funds raised then allocated to credit institutions in France in exchange for collateral. The French governments decision to fund its credit institutions through a separate vehicle proved to be the correct one when it came to pricing and placement.
Indeed, the Eu5bn three year priced at 5bp over mid-swaps, the tightest government guaranteed issue so far. Moreover, 26% was sold to central banks, a much higher proportion than UK banks had been able to achieve in their issues.
"If you look at the distribution figures on UK issuers, bank treasuries, in particular, and private banking networks have been quite big players," says Simpson-Orlebar at Lloyds. "While central banks have started to come in, it has been a slow process. The percentage of paper allocated to the Middle East and Asia is also creeping up. They would probably welcome a Eurodollar. In time, we expect central bank buying to come up as they get approvals and put their lines in place, however, their take-up should remain well shy of the percentages more typically seen in SSA trades."
Only game in town, for now
There is little doubt that bank guaranteed issuance will dominate the screens until at least the end of 2009 when the guaranteed window is expected to shut, unless it is extended by governments. It has proven to be a viable and cost-effective funding tool for bank issuers.
Even when the cost of the guarantee is factored in and added to the new issue spread, issuers are still saving a considerable amount versus unguaranteed debt. If the banks have to pay the same type of premiums as comparably rated corporate issuers, which can be as high as 250bp back of CDS at the moment, it simply does not make sense to issue unguaranteed debt at the moment. However, market participants expect that at some stage the market will see a return of unguaranteed issuance from banks.
"Clearly, these are intermediate measures the aim of which is to restore confidence," says HSBCs Bothamley. "However, over time banks will have to fund themselves outside the guarantees. In the meantime though, the guaranteed issuance is giving the credit market a chance to recover and react positively to the fact that there is not much supply and ultimately, that should facilitate a return of unguaranteed issuance."