FIG bonds: pessimism has been banned
The yields on bank bonds have reached their lowest ever levels in recent weeks, thanks to meagre issuance and accommodative central bank policy. These conditions mean investors can see the silver linings, but not the clouds — and there are plenty — behind them.
Conditions in the financial institutions bond market are bordering on the surreal.
Take Alpha Bank. The Greek lender, rated Caa1/B/CCC+, sold €500m of tier two securities at 4.25% last week, “a level unthinkable even a few months ago”, as Rabobank analysts put it.
It was able to tighten pricing by 75bp-100bp and the deal was 10 times subscribed, with orders from 350 accounts.
Many have said that asset quality will remain a credit challenge for Greek banks for several years. Indeed, Alpha Bank’s non-performing exposure (NPE) ratio was 48.9% at the start of 2019, and only fell to 44% by September.
At least 350 investors do not seem to care. Credit fundamentals clearly did not drive pricing on the Alpha deal.
Investors instead seemed to take comfort from what Greek banks aspire to do with their NPEs.
Alpha Bank wants to reduce its NPE ratio to less than 10% by 2022 and cut provisions for possible credit losses to less than 70bp. The most recent figures are 44% and around 200bp.
It intends to use three tools to deliver these results. Securitization, it hopes, will deal with €12bn of NPEs; it will outsource a further €7bn; and carving out an NPE platform to an independent entity will deal with the rest.
This effort is in parallel to what Alpha’s peers are doing. The four largest Greek banks — Alpha, Piraeus Bank, National Bank of Greece and Eurobank — have reduced their gross NPL ratios by 10 percentage points in the past three years. They stood at 37% as of the third quarter of 2019.
That is all well and good. But as Marco Troiano, deputy head of financial institutions at Scope Group, put it, “even assuming all the targets are met, Greek banks’ asset quality will still compare unfavourably with European peers in 2022”.
And that assumption is a big one. Alpha Bank’s plans sound good but are rife with execution risk. If it took three years for the sector to cut 10 percentage points off the NPE ratio, getting all the way down to under 10% in another three sounds a stretch.
Nonetheless, investors — desperate for any sort of yield — seem to prefer to focus on the positives rather than the negatives.
Alpha’s lead managers used tier two transactions from Greek peers as anchors to determine pricing. These transactions were issued last year: National Bank of Greece paid 8.25% in July for its €400m issue, which attracted €1.65bn of demand; and Piraeus Bank raised the same amount at 9.25% with €850m of demand from more than 135 investors.
That Alpha was able to achieve such a deal as last week’s, at half the yield, despite no great change in its credit, shows that investors have been driven wild in their search for returns.
Expansion into higher yielding names has not been confined to Greek issuers. Another striking example was the issue in January by Italy’s Banca Monte dei Paschi.
The Italian lender has had more than its fair share of problems and underwent a precautionary recapitalisation in 2017. It was required to raise €1.45bn of tier two capital as part of a restructuring plan instructed by the European Commission in that year.
In July last year, Monte obtained €300m of tier two from a €750m book of demand, paying a 10.5% yield. But even better conditions this year prompted it to raise more capital towards its tier two target.
The new tier two in January was an impressive feat for Monte. Demand reached €900m, allowing it to print a €400m deal paying an 8% coupon.
For issuers the traffic lights are clearly green, as far as the eye can see.
There is no doubt that more banks will come to the market soon — indeed, Piraeus Bank showed up on Monday, saying it wanted to issue tier two. The levels will almost certainly be far better than any it has achieved for years.
But for investors, this landscape is deeply disquieting. Non-performing loans and weak banks are a chronic disease in Greece and Italy. There are real hopes that these economies may at last be seeking a cure. But salvation is still a long way off.
Investors are still, in essence, taking exposure to a similar set of perils as they have over the past decade.
The difference is: they are being paid a fraction as much reward for taking the risk.