A brave new FIG world as era of low spreads and coupons end
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A brave new FIG world as era of low spreads and coupons end

Euro sculpture in front of Eurotower, European Central Bank Building, Frankfurt, Germany, Europe
 Photo © Fabio Mazzarella/Sintesi/Alamy Stock Photo

Financial institutions have grappled with an increasingly expensive primary bond market in 2022. As interest rates continue to climb and investors demand more spread for their cash, how much will banks have to pay up to play in the primary markets in 2023? By Frank Jackman.

As financial institution borrowers rushed out of the blocks in the first two months of 2022, none would have anticipated the market turbulence caused by Russia’s invasion of Ukraine in late February. Having only just got to grips with rates volatility at the start of the year, banks found themselves navigating an even more uncertain market.

A look at one of the banks most exposed to the CEE region — Raiffeisen Bank International — shows just how drastically yield curves have been repriced over the past nine months. When the Austrian national champion came to print a three year green senior deal in late August, its first bond issue since the start of the war in Ukraine, investors demanded a spread of 200bp over mid-swaps. Only one year earlier, it had priced a six year senior deal at exactly a fifth of the spread.

Although Raiffeisen, to an extent, is a special case, the rapid widening in spreads in 2022 penetrated all segments of the FIG market as rising interest rates and volatility put an end to the era of low spreads and miniscule coupons.

Euro and sterling new issue data taken from GlobalCapital’s Primary Market Monitor shows just how pricey issuance became in 2022 — and could continue to be — for financial institutions.

Spiralling spreads

Banks started 2022 in similar fashion to the end of 2021, with euro funders paying an average of 87bp over mid-swaps in January and February, compared with 80bp in the final two months of 2021. However, when issuance resumed in the latter half of March the average spread had widened to 123bp. As the year progressed, banks have found themselves paying higher spreads despite shorter maturities. By the summer, triple-digit spreads were commonplace across the stack.

“This has been a bad year for investors, with equities and bonds down [roughly] 20% to date,” says Joost Beaumont, head of bank research at ABN Amro. Because of this, “banks have had to offer wider spreads to compensate.”

As a result, the average premium for a syndicated senior deal in euros or sterling climbed from 8.29bp in January 2022 to a year high of 47.83bp in July. Senior premiums averaged 13.03bp throughout the first half of the year, 2.5 times 2021’s 5.13bp average. By September and October, this had risen to 24.47bp and 30.07bp, respectively.

This spike in July was driven by a pricey deal from Aareal Bank, which chose to pay the highest senior concession of 2022 to round off its unsecured funding ahead of what it thought could be a busy but uncertain autumn.

Meanwhile, the average additional tier one (AT1) deal was priced with a 40.45bp concession throughout 2022, up from 10.34bp a year earlier. Tier two deals carried 23.32bp of premium on average, a far cry from 2021’s 6.44bp.

Elevated concessions were necessary to offset a more nervous investor base. Bid to cover ratios fell across the capital stack, while banks found it increasingly hard to rein in spreads as accounts became more selective.

In 2022, 21 issuers failed to tighten trades in euros and sterling, up from 12 in 2021, according to Primary Market Monitor data. The bulk of this paper came from smaller names or debut issuers, with investors showing a greater preference for more liquid firms as the year progressed.

The trades that struggled to shave off any basis points were, on average, 1.17 times covered, 42% lower than the market average of 2.01 times. Furthermore, they had to pay an average concession of 51.4bp to land their deals.

As banks faced the prospect of trickier visits to the market as 2022 progressed, they looked to cushion themselves from execution risk as much as they could. Some turned to labelled deals to capture every patch of demand. In 2021, banks placed €28.23bn of labelled senior debt; by the end of October 2022 they had issued €39.30bn.

Others opted for shorter maturities. Despite starting 2022 with an average maturity of 8.72 years, the senior debt market ventured shorter as conditions worsened. By October deals were being printed with an average duration of 5.25 years.

End of an era

The end of negative rates in the eurozone and the rapid rise in the ECB’s deposit rate since July ushered in a sharp jump in bond coupons. The ECB increased its deposit rate by 50bp in July, its first rise since 2011. Two successive 75bp rises followed in September and October as the central bank attempted to bring inflation under control. Further increases are expected in the coming months.

“We have left the era of negative interest rates behind us,” Beaumont says. “The unprecedented pace of central bank hikes has been reflected in interest rates and swaps, leading to banks paying higher coupons.”

For instance, the average coupon for bail-in senior deals rose from 2.84% in July, ahead of the ECB meeting, to 3.79% in August. This jumped further to a year high of 4.74% in October — almost eight times the 0.62% average offered in October 2021.

However, this ECB-fuelled rise in yields might wane in the latter half of 2023 as the central bank’s deposit rate tops out. Rates strategists at DZ Bank expect that the ECB rate will peak at 2.50% in March.

Central banks could then look to start cutting rates in the latter half of 2023, and as a result drive bond coupons lower, Beaumont suggests.

Banks will certainly welcome any lower coupons later in 2023 as refinancing of the Targeted Longer Term Refinancing Operations (TLTRO) funds gathers pace and they keep one eye on January 2024’s minimum requirement for own funds and eligible liabilities (MREL) deadline.

Senior secured and unsecured issuance is set for another bumper year, with analysts at ING expecting €370bn, only €10bn less than in 2022.

Some banks have already started tackling the TLTRO cliff edge in 2022 by ramping up their covered bond issuance to a level that surpassed expectations. By the end of October, banks had placed €168.19bn of senior secured paper, with a flurry of deals in November pushing the total to a double century for the first time. In 2021 only €105.57bn was raised in the format.

Of course, not all this refinancing will be done in secured format. Banks have tapped the senior market in larger sizes in 2022 than in 2021. The Primary Market Monitor recorded 224 syndicated euro and sterling senior tranches totalling €180.99bn in the first 10 months of 2022, for an average deal size of just over €800m equivalent. Although a larger number of notes (241) was issued in the whole of 2021, the volume was roughly in line at €180.01bn, meaning that in 2021 the average deal size came to just under €750m.

However, the focus and reliance on senior secured and unsecured funding in 2022 has come at the detriment of riskier subordinated trades. The volume of euro and sterling AT1 paper fell by almost half, dropping from €14.20bn in 2021 to €7.59bn by the end of October. The fall was similar in tier two debt, which declined from €40.69bn to €23.30bn in 2022. GC

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