Banks open up for senior in post-Covid adjustment
As Europe starts to emerge from its coronavirus lockdown, economic restrictions are being eased and banks are returning to funding in the public markets. But the environment is markedly different from that which went before.
The tail-end of April saw bank issuers including BPCE, Swedbank, Arkéa and Santander back in the senior market, while activity really started to hum in the first week of May when six European borrowers brought deals. The clear upshot of the early action is that while deals in non-preferred senior format have gone well, the FIG sweet spot is in the senior preferred asset class, says Christian Klocke, credit syndicate at DZ Bank.
“The situation has changed very much in favour of senior preferred,” he says. “Given the action of central banks, liquidity is not a topic for issuers. Instead it is relative value and senior preferred offers good relative value and a significantly higher level of execution probability because all types of eligible investors are participating.”
The senior preferred market also ticks funding boxes that the huge expansion in central bank liquidity facilities can’t, says Conor Hennebry, European head of DCM and syndicated lending at Santander.
“Being able to access unsecured financing is still important for many banks as part of their overall funding strategy for the year,” he says. “The senior preferred bond market is also much more effective on certain ratios where central bank funding is less efficient, for instance the net stable funding ratio.”
Spreads for senior preferred, while still wider than pre-crisis, have returned to attractive levels for borrowers, certainly relative to covered bonds which are competing with central bank liquidity facilities available at exceptionally favourable terms. Hennebry expects some issuers to look to covered bonds this year if long-dated spreads are attractive, or if there is a desire for diversification, but otherwise a very large reduction compared to pre-crisis expectations.
Borrowers such as Erste Group Bank, which issued a €750m seven year senior preferred deal on May 6, will likely issue less than its usual €2bn of covered bonds this year because of the more attractive terms of the central bank facilities, says head of group funding Bernhard Leder, but that doesn’t preclude accessing the public market for term funding. “Even if there are exceptionally attractive funding opportunities like now with the TLTRO 3 you don’t want your funding curve getting short or having any particular concentration,” he says.
The relegation of senior non-preferred in favour of senior preferred has been a striking aspect of the market in early May, with all six of last week’s deals in the asset class.
Across Europe, regulators are relaxing rules on bail-in capital, giving issuers more space to fill subordination requirements and reducing the need to issue non-preferred senior which otherwise would have comprised a large chunk of funding needs this year. At Dankse Bank, for instance, head of group funding Bent Callisen, explains that its senior requirement would have had to be non-preferred senior, but because the Danish FSA pre-implemented a BRRD II subordination cap, it can also in part use preferred senior for MREL. “Broadly speaking, this means that we can replace maturing preferred senior with new preferred senior instead of replacing them with non-preferred,” he says.
But while the regulatory relief means that banks have been given longer to fulfil their senior non-preferred needs, most of them probably need to get to the same destination at some point, while rising risk-weighted assets due to the crisis might raise requirements for banks, says Hennebry. ”Extra loans are being extended, more loans are being drawn down and there is potential for credit quality to fall, so overall senior non-preferred requirements will probably be similar to what we expected before the crisis,” he says.
If senior preferred is currently the popular choice of issuers, it also works for investors. “It makes sense for investors. It's highly rated and can therefore easily absorb some rating migration, the pricing is reasonable for investors looking for some yield, and there is less spread volatility than non-preferred senior,” says Klocke. “Bank treasuries are very active. Deals come with positive yields whilst being eligible as ECB collateral. That said, also asset managers and other real money buyers are currently taking a very constructive role in books.”
The recent spate of deals have been particularly popular with the German co-operative bank sector, which has been keen to get highly rated paper with yields of around 1%. “Germany and Austria is the second largest investor base for Arkéa,” says Laurent Gestin, an investor relations official at Crédit Mutuel Arkéa, one of the first issuers to return on April 28, also with a €750m seven year senior preferred bond. “While obviously we had large orders from the large institutions there, we also had a good share of orders from investors that are smaller and helped bring the transaction in good shape. It's always amazing to see the number of small banks that invest in our bonds.”
Likewise, SBAB Bank, which issued a €500m five year senior preferred bond on May 6 under its green bond framework, saw support from smaller investors such as the co-operative sector and savings banks in Germany as well as from larger accounts in Germany, France and Benelux together with a strong showing from Nordic buyers. “It was a strong and diversified order book that shows there is interest for this kind of product on very broad basis,” notes Anders Hult, head of funding at the Swedish lender.
Deal performance has been strong, a factor that can be attributed on some deals to the participation of the German co-ops, says Klocke.
“The highly granular co-operative sector’s firepower to deliver follow-up demand in secondary markets to meet desired allocations helps drive performance,” he says. “We’ve seen that in, for instance, Erste’s trade which has tightened 15bp since pricing, and in SBAB, which is similarly tighter. Deals that haven’t involved the co-operative sector haven’t seen the same performance.”
The market is doing well but the outlook is far from clear as the full repercussions of the economic damage wrought by the crisis are yet to be felt, so issuers are being urged to take advantage of conditions while they last.
“Economies are in historically bad shape and we’re nowhere near the wide spreads we’ve seen in other crises so there’s clearly a risk that spreads might suffer significantly,” says Klocke. “Banks need to take the opportunity to fund themselves and I struggle to see a significant fall in spreads in the next six to nine months without a significant turnaround in global economic conditions.”