SSA underwriting fees: lowering them will do more harm than good
Public sector borrowers should be careful what they wish for. Those looking to follow the European Union’s lead in lowering the underwriting fees they pay to banks could cause an unwelcome distortion to their market at a time when getting funding through the door with minimal drama is perhaps more crucial than ever.
The SSA fees debate was triggered after the EU published a lower fee schedule last month for its €800bn Next Generation EU funding programme. The EU will pay, on average, 0.068% less across the curve for syndicated transactions than the standard fees in the SSA market.
But the fees for the EU’s NGEU programme should not form a precedent for the market.
The EU will raise €150bn a year – mostly through syndications, at the start of the programme at least – making it a different beast from any other public sector borrower. No other issuer comes close to this scale of syndicated activity.
The EU's gigantic borrowing programme is also not supposed to be permanent. Once the €800bn has been raised by 2027, the debt will start rolling off and the average maturity will shrink until 2058, by which it is to be repaid.
Perhaps the strongest argument SSA issuers have for lowering fees, besides copying the EU, is that the current fee schedule is not proportionate to the underwriting risk banks take, in the age of huge central bank bond buying. Fees were last reset in the aftermath of the global and eurozone financial crises.
But this is naïve. Yes, monetary policy has propped up the bond market. But the fees cover so much more than underwriting risk. Borrowers are also paying for the health of the secondary market, which gives investors the confidence to know that if they want to, they can trade their bonds and that prices maintain a degree of stability.
That doesn't come free, and yet it saves issuers many more basis points over time in avoided price shocks compared with the basis point or so they would save from lower primary market fees.
In fact, in the case of primary dealerships, this is a loss-making service where syndication fees are used to cover those costs. There are also plenty of other bonds banks sell for issuers that don't make them much, or any, money. Admittedly much of this is done in the name of winning fee paying syndications but it is still cheap, even subsidised, funding for borrowers.
Reducing fees – which are already lower than in some other markets – would put further pressure on the bottom line for banks, leading to a weakened market as resources were directed to more profitable activities.
Fewer banks will mean reduced competition, which will weaken the quality of the service issuers need. This could even lead to increased fees if the pool of banks left is so small that they are able to dictate the fees themselves.
The primary dealership model has been under severe pressure for years with various banks pulling out of it either in specific markets or altogether. Lowering syndication fees would be another final nail in the coffin.
Issuers also demand banks provide them with advice and constant updates whether they are ready to print a deal or not. That requires boots on the ground and an array of skilled staff. The more experienced they are, the more expensive, of course, but the better that advice will be.
Would an issuer charged with raising funding at the best cost for the public purse be better off doing deals recommended by junior bankers with advice from traders whose experience goes back just a few years, or from seasoned veterans who have been through numerous crises and who have been shown to have a good read on their market in all sorts of conditions?
Banks will compete for whatever fees are available. It is baked into the business model. But as one syndicate banker warned it could spark a “race to the bottom”.
That means it is up to issuers to think about the long-term value of a robust SSA bond market to their funding costs.
Simply assuming that doing deals is easy at the moment because central banks are underpinning the entire market is short-termist and naive.
Issuers have borrowing programmes to get through that are bigger than ever and the world is still not out of the pandemic. The future is unpredictable. Borrowers have a duty to ensure that they do nothing that makes their market similarly so.
Now read the opposing View by Lewis McLellan.