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MREL bonds: the time is now

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By David Freitas
21 Apr 2020

Financial institutions with funding needs that are holding off in anticipation of better issuance conditions are doing it wrong. Waiting until the other side of earnings season to bring deals will likely prove a mistake.

The journey that credit spreads have made in the past few months across financial institution bonds has been nothing short of remarkable.

Crédit Agricole in January, when conditions had never been better for banks, issued a 12 year bail-in senior bond at 70bp over mid-swaps.

The initial burst of economic disruption from the coronavirus pandemic led to a sell-off in the bond market, driving the bond to 200bp over a month ago. The market has not fully recovered but it has improved and the notes now trade at around 130bp over.

The same bank sold a non-preferred senior bond last week and paid 125bp over mid-swaps for the six year non call five paper.

The levels are elevated compared to recent history but the likes of Crédit Agricole and BNP Paribas, which also sought funding last week in a similar format, only had to pay single-digit premiums to access the market. That leaves little room for complaint in the wake of the recent volatility amid a pandemic with no end in sight.

And even if the spreads have risen, yields are still pretty low by historical standards. 

However, some issuers are waiting it out, preferring to lean on cheap central bank liquidity to keep themselves going.

But these instruments, like the Targeted Longer-Term Refinancing Operations (TLTRO) from the European Central Bank, do not have any regulatory value. Therefore, they cannot factor into a bank’s minimum requirements for own-funds and eligible liabilities (MREL) and they cannot be used to absorb any losses.

This is why the market is still the place to go to print bail-inable debt.

But the market has been a tricky place to do business of late. Good conditions one day have not meant similar or better the next. Given that recent history, being able to pay single-digit concessions to build the regulatory buffers does not sound bad at all.

Meanwhile, in the US, banks have started disclosing their earnings for the first quarter. Bank fundamentals across the board seem to be sliding in tandem with the economy, which looks dire.

For instance, Goldman Sachs, Bank of America and Wells Fargo last week reported drops in their common equity tier one (CET1) ratios, signalling trouble stemming from the coronavirus outbreak.

Surely European banks will tell a similar story. And the picture is set to get much worse in the second quarter as recession starts to bite.

In many European countries, as well as in the US, the coronavirus cases are rising. And there is no easy fix in sight — for the virus or the economy.

All of that means, barring a lockdown let-up and subsequent uptick in economic activity, that markets will not get much better than this for banks in need of funding.

Therefore, it makes sense for issuers to get issuance over and done with now, before disclosing earnings, and giving investors something else to worry about.

Waiting until after earnings season, means spending a lot more time explaining strategies to cope with the negative effects of the coronavirus on the economy and justifying one's institution's credit story.

Borrowers that get on with their bail-inable funding now will be thankful not only for the single digit NIPs they pay, but the relative ease with which they printed their bonds.

By David Freitas
21 Apr 2020