Banks are vulnerable to negative changes from the turning of economic cycles. The myriad issues currently facing European financial institutions — from the proximity of the war in Ukraine, recession and inflation fears — are signalling that it is ever more vital to obtain funding sooner rather than later.
Amid too much macroeconomic uncertainty ahead for the remainder of this year, bank issuers should be pragmatic and secure their annual funding needs as soon as possible.
Aside from the grim macroeconomic predictions clouding the outlook, the capricious stop-go environment in the European primary capital markets have further exacerbated banks’ ability to raise new funding, returning memories of the vicious circle from the early summer.
The return of volatility this autumn means spreads and new issue concessions are likely to move higher once again, coupled with lower subscription ratios for deals.
This provides a disturbing sense of deja vu that trades may get pushed back and compound a vicious circle.
Bitter spring
As inflation started to rear its ugly, uncontrolled head this year, joined quickly by uncertainty and economic woes caused from the war in Ukraine, the unsecured FIG market in euros became awash with volatility. New issuance turned into a rollercoaster ride, marred by frequent stop-go patches.
Senior and especially subordinated trades were pushed later and later. Dealers told GlobalCapital in mid-July that at least a handful of tier two securities from banks and insurance companies were postponed until the autumn.
Then the massive rally across asset classes ensued over the second part of July, and most of August.
In credit markets, the iTraxx Europe main index dipped through the 100bp threshold for the first time in two months on August 10. After tightening through the 500bp level in early August, the Europe Crossover index completed several prints in the high 400bp area, again some of the tightest seen in nearly two months.
The story for the cost of protection on European banks’ senior and subordinated paper is similar. The iTraxx Europe senior financial index shed 30bp between August 12’s 99bp closing and the multi-year high of 139bp level from July 14. The summer lull provided an even bigger tightening for the subordinated financials index, which narrowed by 71bp in the two-month off period between July 14 and August 18.
This rally was short-lived, however.
'Reality check'
It did not take long after the resumption of the unsecured FIG market on August 15 to bring back the stop-go environment. Last week’s contrasting tale of two halves illustrated European banks’ need to capture a funding window whenever it opens.
After a strong, earlier-than-usual restart to the autumn unsecured FIG issuance on August 15, a sudden turn in market mood damped the sentiment in the first two days of last week. Despite bankers reporting that senior preferred and tier two deals are what investors now most desire from within unsecured FIG asset classes, each type struggled last Monday.
Deutsche Pfandbriefbank's €500m four year senior preferred bond was stuck at the same levels as initial price thoughts, with demand of just €550m. NN Group’s €500m 20.5 year non-call 10.5 tier two faced a similar fate, unable to move from the initial guidance, though its book reached more than €1.1bn.
While both issuers got their funding done, what stands out is that the pair are from core eurozone countries. This suggests that it will likely be far harder for periphery borrowers as well as weaker or smaller names in other core jurisdictions to access the capital markets.
It is, however, not only a problem for the smaller or weaker banks.
Rabobank, hailed as one of the best quality global financial institutions, issued its first tier two debt in more than eight years on August 22. The Dutch lender was surely able to breach its pricing past the sub-200bp spread — with its super rare tier two — but it attracted an order book of just over €1.1bn for its €750m size.
In contrast, only a few days earlier, Swedbank and Rabo’s compatriot ING were able to attract coverage ratios of 4.4 and 2.6 times for their respective €750m and €1bn tier two transactions.
Poor macroeconomic data was to blame, along with heavy unsecured FIG supply — €9.4bn issued in the single currency since August 16 — giving the market what one senior banker called a "reality check". Unsecured FIG issuance then came to complete standstill on Wednesday.
This clearly shows that the sentiment-driven market can sway the funding fortunes of even the best and most-recognised global issuers.
And then, a lightning fast mood recovery occurred on Thursday, resulting in more than €10bn of orders pouring €3.75bn into a trio of senior bank bonds. Last Friday, UK’s Nationwide Building Society rode this sentiment to issue a €750m seven year preferred deal on the back of €2.3bn of orders.
After a public holiday in the UK on Monday, the week started on August 30 on the front foot for FIGfunding but by the late European afternoon, market conditions fast deteriorated again, hinting at a likely return of the stop-go windows.
Economic woes
In this kind of a stop-go market, issuers should be pragmatic and secure what they need in terms of senior and subordinated funding as early as they can. There is no point in waiting for the optimal moment when they can shave off a couple of basis points.
This may sound like a syndicate official’s mantra being pitched to an issuer. But these are not regular times — winter is coming. And this winter, if half the predictions come true, will be like no other seen by the past generation.
Banks’ euro senior paper has already widened more than 50bp this year while the spread on subordinated debt has gained more than 90bp. And analysts across asset classes see gloom ahead, at least until the end of 2022.
Sky-high energy prices are prompting the EU and the UK to consider state supports similar to the Covid-19 measures. The cost of food and basics necessities have moved up in tandem with annual inflation increasing 0.3 percentage points month-on-month in July to reach 8.6% in the eurozone. Inflation has hovered far higher in countries like Poland and Hungary, respectively, reaching 15.6% and 13.7% in July, according to Trading Economics.
JP Morgan economic research sees a high likelihood that the UK will enter into a technical recession in the fourth quarter due to “soaring gas prices”. ING expects the eurozone to slide in a “shallow recession” within the third quarter.
In this environment some credit researchers consider it very unlikely to have much clarity on bank fundamentals before the end of third quarter, at earliest.
Delaying funding, amid an imperfect yet open window, could risk creating the same vicious circle of postponed deals the market witnessed before the summer.