“Transitory” would surely come top of any shortlist for word of the year in the financial markets in 2021. As a way of quelling fears that the global economy might overheat, central banks have stressed time and again that inflation is only rising because of transitory factors linked to the recovery from the pandemic.
But market participants have developed their own views about what may or may not be transitory, preferring to err on the side of caution when it comes to inflation expectations.
They overwhelmingly expect that exceptional support programmes will have to be wound down, and that interest rates will have to rise, to keep the economy in check.
Such a withdrawal of monetary stimulus is easily the biggest risk facing FIG borrowers in 2022, according to the results of a market survey carried out by GlobalCapital in November and before the Omicron variant reared its head.
Banks have gorged on central bank liquidity in recent years, with eurozone lenders drawing a staggering €2.3tr from the European Central Bank’s latest round of targeted longer term refinancing operations (TLTROs).
But the terms of the TLTROs will deteriorate in 2022 if the ECB lets its programme phase out naturally, which could prompt banks to think more urgently about how they should fund their balance sheets after the pandemic.
“We expect any moves on this front to be at a measured pace, and so banks should have time to respond accordingly,” says Mark Geller, global head of banks DCM at Barclays. “But it should encourage banks to consider refinancing in the capital markets.”
More than half of survey respondents (61%) said they expected the market would be busier in 2022, with issuance to be led by preferred senior debt, non-preferred senior debt, and covered bonds. Just under a quarter (23%) thought supply volumes could be more than 20% higher year on year.
Spreads will widen
Other factors could also increase the funding pressure on European lenders in 2022, alongside the partial withdrawal of central bank support.
Christopher Bond, head of FIG DCM, EMEA at BNP Paribas, notes that banks had enjoyed a lot more flexibility in the market in 2021 because deposit balances remain “very high”.
Eurozone bank deposit inflows roughly doubled while countries were in lockdown in 2020, according to ING Research, before returning to a more normal pattern in 2021.
“If deposits start to reduce as we recover from the pandemic, then banks may need to tap the funding markets more,” Bond says. “This will present another challenge for execution dynamics [in 2022].”
Warning lights were already flashing in the second half of 2021, as credit markets felt some of the fallout from a prolonged period of global interest rate volatility.
Banks have had to pay about 10bp of new issue premium on their senior deals in the autumn and winter, compared with an average of closer to 5p before the summer.
The higher toll on new issuance has gone hand in hand with a slight widening in credit spreads, which had been almost completely flat in the first half of the year.
Market participants are convinced that credit spreads will continue to widen in 2022, across preferred senior, non-preferred senior, tier twos and additional tier ones (AT1s).
Half of those surveyed said spreads in all four asset classes would widen. Participants were least convinced in the case of AT1s, where 65% expect widening, and most convinced in the case of tier twos, where an overwhelming 85% of respondents expect widening.
“In the short term, it feels like tier two is vulnerable,” says Bond at BNP Paribas. “The asset class did not experience the same impact as other asset classes during the October sell-off, so you can certainly see the case for some widening.”
If spreads are set to move wider then FIG borrowers will need to think much more carefully about how and when they approach the capital markets in 2022.
Market participants expect dollars will be very accommodating for larger banks looking to issue in size, even in the face of tightening monetary policy.
More than two thirds (69%) of survey respondents say the dollar primary market will be as reliable as it has been in 2021, with a further 8% suggesting it could more reliable.
Banks will also hope to have clear access to alternative markets if supply volumes increase, as deals could end up being crammed into smaller and more sporadic issuance windows.
“For most of [2021], the pricing between G3 currencies has been much closer than we’ve seen historically,” notes Mark Pearce, head of financial institutions syndicate at HSBC. “If that holds into [2022], issuers will be able to look at multiple markets and they won’t be overburdening any one currency.”
Survey respondents are unanimous in suggesting that banks will want to skew their issuance towards the start of 2022, though only half think they will frontload more than usual.
Christoph Hittmair, global head of financial institutions DCM at HSBC, says some borrowers have already started to get itchy feet. “When it became clear that economies were re-opening, a lot of issuers felt good about the outlook and they thought they would have plenty of options in terms of funding windows,” he says. “Now we are at the end of the year, I think the view is now that things won’t get much better. There is no longer much upside to waiting.”
Times are changing
Though storm clouds are gathering, most market participants expect frequent funders will still have strong enough support to be able to manage their expanding funding programmes.
But a softening of market conditions would prove much more challenging for second and third tier banks, many of which are still looking to optimise their capital structures or bring in more debt to meet the minimum requirements for own funds and eligible liabilities (MREL).
Most survey respondents (58%) think smaller issuers will find it tougher to access the market in 2022, with only 8% expecting these names to have it any easier.
Pearce at HSBC says he saw evidence in the closing stages of 2021 that some large accounts were shifting to focus more exclusively on national champion names.
“There is some potential this isn’t just a seasonal thing,” he says. “If investors think we are coming to the end of a bull credit cycle and that the path of spreads will be wider, then there is potential for underperformance in small, off-the-run and niche credits. We are already starting to see accounts requesting a larger illiquidity premium.”
There have been times over the last five years when it has felt as though central banks would never be able to roll back on their support for markets. But a rapid loosening of monetary policy during the coronavirus pandemic has left policymakers in a position where they now need to take away stimulus, instead of just handing more out.
Looking at the next five years, FIG market participants find it hard to believe that issuance conditions can be anywhere near as straightforward as in recent times.
Slowly but surely, borrowers are waking up to the idea that the era of ultra-easy money could prove to be transitory. GC
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Banks struggle for fast progress on SLBs Sustainability-linked bonds (SLBs) arrived in the FIG market in 2021, as Berlin Hyp burst its way on to the scene. Through its transaction in mid-April, the German lender made a clear and ambitious pledge to reduce the carbon intensity of its lending stock by 40% over the next decade. It sold a €500m 0.375% 10 year senior SLB at 35bp over mid-swaps, though the final coupon could step up by 25bp if the issuer misses its sustainability target. Berlin Hyp’s deal laid the groundwork for other banks to think about how they can come up with key performance indicators (KPIs) of their own. But work on bank SLBs was quickly stopped in its tracks after the European Banking Authority took a dim view of the structures. It said SLBs were likely to fall foul of the standards set out in the minimum requirements for own funds and eligible liabilities (MREL) because of the penalties embedded in the terms and conditions. A November survey carried out by GlobalCapital reveals that market participants now see little prospect for further growth in bank SLB volumes in 2022. Just under a quarter of those surveyed (73%) say the asset class will remain niche in FIG in the next year, though there could be some supply. Two respondents explicitly said further issuance would be limited unless deals could be counted as MREL. But some market participants remain constructive about the regulatory status of SLBs, arguing that banks simply need to find an alternative to deals with coupon step-ups. “It will not necessarily take a long time to confirm regulatory eligibility and investor interest once we have come up with the right structure that respects the constraints applicable to capital instruments, while having real consequences if the KPI is not met,” says Gilles Renaudiere, a director in capital products and DCM solutions at BNP Paribas. “But you also need to be able to document the KPI itself, which may take more time. Banks have communicated on the net zero objectives over the longer term and now they need to come up with intermediary targets.” GC |
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