Government guarantees for bank paper spurred investors on to invest in the financial sector in both the public and private markets from the last quarter of 2008 and into 2009. But issuance of that kind is waning in the private market, as investors look towards the much more generous spreads available from unguaranteed bank paper.
The number of public unguaranteed issues overtook guaranteed issues in April. Since then the unguaranteed market has been growing still stronger as investors have become comfortable with the idea that banks will not be allowed to go bust by their governments and that issuers can always refinance unguaranteed deals with guaranteed debt if necessary most guarantee schemes run for three to five years and many observers expect some of them to be extended.
As is often the case, the private market is following the public market. The large oversubscriptions of deals in the public market and clearly buoyed investor confidence in the banks has trickled down to the private market.
"This was the obvious trade from the moment the guarantees were introduced, but its taken time for people to feel comfortable again and get approval to increase exposure to financials," says Toby Croasdell, vice president of MTNs at Barclays Capital in London.
Although some investors still prefer the liquidity that a benchmark deal offers, confidence has returned enough that many are willing to invest in smaller private placements.
In the private market, demand for guaranteed and non-guaranteed financial institution paper is healthy although of the two, dealers are finding it easier to place non-guaranteed paper. Some governments such at the UK set limits on how much paper of this type each bank can issue and many borrowers are now full on their guarantee allocations. For many UK banks, issuance of this sort is now only possible as a rollover trade.
Luckily however, that has coincided with some return of investor confidence for these names.
Short dated senior unsecured paper had for much of the year been trading wide as investors needing liquidity would sell the bonds closest to par, thereby depressing the price. This made it unattractive for issuers to sell this type of paper they would have had to issue in line with or close to secondary levels. But now that investors are buying in these maturities, much of the attractive secondary paper has been mopped up, opening the door for new issues.
However, investors remain cautious. Enquiry varies name by name, and banks from some countries are less desirable. The UK, Spain and Ireland are avoided by many investors because of real and perceived economic risks.
There has also been a rise in covered bond issuance as investors seek out low-risk alternatives to government guaranteed bank paper, also following a trend set in the public market.
"Theres been a rise in privately placed covered bonds, especially out of Germany," says Amaury Gossé, head of MTNs at Commerzbank in London. "They wont be able to completely replace government guaranteed issuance with covered bonds, but the fact that were seeing more covered bond enquiry and greater appetite from German investors for covered bonds is a good sign."
Structured note return
The return of some non-government guaranteed financial paper has led to a rise in structured note enquiry as well. Only vanilla paper was covered by many government guarantee schemes, and as faith in financial instiutions has returned, so has the lure of structured notes.
In general, banks prefer to print senior unsecured paper as they do not want to rely on government help. But few are willing to offer yields wider than the government guaranteed pricing level plus the government guarantee fee in order to encourage this issuance.
"An extension of the guarantees for the banks doesnt look that critical now for the the return of the structured notes market, unless obviously if the current positive newsflow turns significantly negative again," says Richad Soundardjee, managing director of structured bonds and MTNs at Société Générale in Paris.
As yet the enquiry for structured notes is strictly for simple structures only interest rate-linked notes such as Libor, CMS and RMS range accruals, callable notes and equity or credit-linked notes.
"I gather the RMS accruals are being sold to one investor, so the deals weve been seeing do not indicate that the structured note market is back yet by any means," says Jacques Lumb, executive manager of group funding at Commonwealth Bank of Australia in London. "But there are a few investors that are happy to dip a toe back into the water with structured notes, and thats a sign that normalitys slowly coming back."
The market is undecided about whether there will be a return of more complex structures notes. So far, enquiry for this type of note is sporadic.
Structured notes have been bought by investors in the past for two reasons. Firstly, as a bespoke product to fulfil certain requirements in managing a portfolio, and secondly, as a way of picking up higher spreads in a low interest rate environment.
Because of the first reason, many think that the structured note market is not dead. Because of the second reason, as credit spreads tighten, as they have been over May and June, investors may now be encouraged to pick up yield by using structured notes.
"When real interest rates are low, there is a real benefit in buying range accruals for example, which give you a real kicker to the coupon over and above cash rates in return for taking some risk on the structure," says Lumb at CBA. "Were back to getting a real pick-up in yield for risk, and I would have thought that now investors would be keen to get back in and get paid 7% for a range accrual rather than 0.5% for a cash deposit."
Others are less optimistic about an imminent return of structured notes.
"Its not completely dead, but if investors can buy household corporate names yielding sometimes more than 8%, why bother buying a structured note?" says
Gossé at Commerzbank.
Puttable FRNs on the increase
Away from structured notes, there has been a sharp increase of activity in puttable FRNs for financial institutions. Although these notes are viewed by some issuers without enthusiasm, over $7bn equivalent of these trades have been placed since the start of the year, according to Dealogic data.
Particularly notable were a Eu1.715bn two year note for Rabobank placed in March, a Eu550m two year note for Natixis placed in February and a pair of Eu500m two year notes placed for Crédit Foncier de France in February and March.
"Theres demand for puttable financial, corporate and SSA issues, but this demand is not met with the right level of supply at the moment" says Soundardjee.
Several dealers report demand for government guaranteed bank puttable FRNs. However, most government guarantees only cover vanilla notes and do not extend to puttables, so the supply of these is limited.
The interest for this type of note comes from both money market funds who can only buy short term paper but want the pick-up in yield as well as more cautious investors who want the embedded liquidity of the note.
But for the issuer, unless there is a good arbitrage opportunity for the pricing level available or the borrower is particularly keen to take funding in whatever form, it is unlikely to want to issue puttable notes rather than bullet bonds.
"Even over the last month there has been more activity in that space," says Croasdell. "I think were at a point where issuers feel comfortable that the levels they can achieve offer a sufficient arbitrage versus their bullet targets and investors still like having the put option to mitigate some of the credit risk."
But some issuers are still wary of these notes, particularly in large sizes, because of the risk that the notes may be put, leaving the issuer with a large funding gap at short notice.
"Well look at these notes, but only in small sizes to do large tickets in this structure carries a very big risk," says Lumb. "Were also worried that it will cut across our commercial paper investors. Were told it wont, but theres no guarantee."
The change this year in which notes issuers are keen to consider, and the demise of the structured note market has changed the landscape of financials issuers of MTNs. Many of the more regular borrowers in this market have fallen by the wayside as the structured note market shuddered to a halt, and others are unwilling to, or not cannot issue.
Kommunalkredit Austria has this year issued only Eu100m in a single FRN private placement in March. By comparison, in 2008 the borrower sold $3.1bn equivalent in MTNs in a variety of formats, including vanilla, range accruals, credit-linked notes, currency-linked notes, CMS and RMS trades.
Some borrowers have almost entirely disappeared from the radar screens. The Benelux units of Fortis, for instance, were once some of the most prolific structured note issuers, raising nearly $2.5bn through 189 private placements in the first five months of 2008. In the same period this year, the now disparate entities have issued only seven MTNs, according to Dealogic data.
Banesto is another issuer which, having previously been a champion of the MTN market, known for its flexibility in the structured note market, has markedly reduced its activity this year. In the first five months of 2008, Banesto sold around $1.4bn of private placements in 53 trades, compared to just over $60m in 17 trades in the same five months of 2009.
The reasons for these issuers stepping back from the market vary.
Fortis has had very public problems but Banestos reasons for scaling back its use of the MTN market are very different. The Spanish bank says that it is so well funded that it does not need to pay the spreads investors are now demanding to buy financials.
"The issuer space has become very disjointed. On the one hand, some issuers are struggling to print and on the other some are now so well funded that theyre happy to sit on the sidelines," says Croasdell. "Youre left with a reduced group in the middle that still want to get some funding and can still pay the market level."
But while many banks have fallen by the wayside for private placements, others financial institutions are mopping up what demand still exists. Large institutions that have managed to maintain strong ratings are more in demand than ever, say some bankers.
"I dont think Ive ever seen so much enquiry for dealers names, such as our own or other double-A names," says Croasdell.
But although the landscape has changed for financials, they are far from done with the MTN market. As is the case for other products, the big questions faced by financials are simply how long until full strength is regained and which institutions will emerge as winners in the long run.