At the start of 2011, a European Commission paper that considered forcing losses on senior bondholders in ailing banks pushed the bail-in debate to the fore. Uncertainty over the future of senior debt has at times threatened to close the market.
The issue has far from disappeared. But it has at least been pushed aside for the moment by wider concerns over peripheral Europe particularly Portugal and Greece.
"Concerns around an Irish bank bail-in pushed senior investors to the brink in terms of their expectations as to where they would stand," said Anthony Tobin, head of FIG syndicate at Bank of America Merrill Lynch. "And although were not completely out of the woods with respect to that, we did step away from the cliff edge."
After substantial issuance in the first quarter of the year and the first half of the second quarter, senior has struggled in recent weeks. Discussion over a new bail-out for Greece has made investors more cautious about risk, and the market is taking its lead from Europes periphery. Increased volatility means that for FIG DCM syndicates, getting the timing right is more important than ever.
"When you get spread volatility and the market gaps around, investors need to be insulated against that via the mechanism of new issue premiums, and we have seen those increase in recent weeks," said Andy Young, head of FIG syndicate at Credit Suisse.
"Its not a level playing field for less well-known names either. In the first half of last year, Iberian banks were funding at attractive levels, and thats much more challenging this year. Investor appetite has become much more sensitive to jurisdiction and name, as well as timing in the market."
Covered steals the show
The rise of covered bonds has prompted some traditional senior unsecured investors to turn away from the asset class, tempted by wide spreads and increased security and even more so in the wake of the bail-in debate. As a result, many senior unsecured deals have been smaller in size.
But there is also concern over the rise in activity in the covered bond market. "Investors are wondering whether the increased issuance of covered bonds, largely driven by an increased sponsorship of covered bonds at a regulatory and government level, is leading to a degree of subordination or asset encumbrance," said Tobin.
"That does mean investors are still cautious around the senior unsecured market and therefore not committing quite as much capital or allocation to that sector as they have done in previous years. That is leading to slightly smaller deal and order sizes from investors, which is something the market has to recalibrate itself towards."
But while there is no denying the trend towards covered bonds, senior is still a huge source of funding for financials and thats not going to change soon.
"Some issuers that have lost senior market access because of volatility still have it in covered, so its the next market to go to," says one syndicate banker. "But overall, traditional credit buyers have quite a bit of work to do before theyre going to replace senior investments with covered, so for the immediate and short term future it will remain the asset class of choice."
Regulation versus capitalisation
Contingent convertibles (Cocos) stole the investment worlds attention during the first quarter of 2011, with deals from Rabobank and Credit Suisse, as well as a Cococo (convertible contingent convertible) from Bank of Cyprus.
But contingent capital aside, issuance of capital and subordinated debt has been subdued this year. Its not for lack of demand buyers are interested, and names such as Pimco are even setting up dedicated Coco funds.
The problem is a lack of clarity over the regulatory treatment of capital structures, as well as differences in the Coco structures themselves. Do they write up or write down? What are the conversion conditions? What exactly is the point of non-viability?
For now, the market is in a sort of regulatory limbo. Against the broader backdrop of Basel III and regulatory changes in individual jurisdictions, the next landmark for capital regulation is the European Commissions fourth edition of the capital requirements directive (CRD 4), which is expected to be released in July. Among the points of discussion are the definition of capital, further counter-cyclical measures, counterparty credit risk, quantitative liquidity standards and systemically important financial institutions.
"We dont know what the regulatory backdrop looks like yet," said Young. "As an issuer you cant really issue capital until youve got regulator sign-off there is little point in issuing bank capital if it doesnt get regulatory treatment. Thats whats restricting supply at the moment, and it will continue to do so until the regulators publish the new rulebook."
"Secondly, the structures regulators allow will have a big impact on what kind of demand there is from investors, and how expensive new structures will be."Every market needs a breather from time to time, and while regulators pore over proposals and politicians posture over Greece, it seems the FIG market is experiencing one. But the second half of the year will be full of challenges. FIG bankers had better not get too comfortable.