Copying and distributing are prohibited without permission of the publisher.


UK financials well placed to ride wave of recovery

28 Sep 2010

Coming out of the financial crisis in quite a different form to how it entered, the UK banking system has grown and evolved as a result of the challenges faced over the last three years.

As the structure of institutions themselves has changed, so the funding teams have developed their strategies for accessing markets and finding liquidity. They have picked a path through market worries about refinancing amounts, and adjusted to an evolving investor base.

Borrowers have learnt the crucial importance of being quick-footed in their market forays, cultivating an array of funding sources, and communicating openly with investors. Their funding sources are expanding: covered bond and senior unsecured markets have been open for some time, and securitisation is returning.

Meanwhile, the industry remains worried about the regulatory outlook and thirsty for clarity over incoming rules and their interpretations.

This roundtable brought together some of the country’s top bank borrowers and FIG debt capital markets bankers in London to discuss the challenges and opportunities facing UK financial institutions in today’s funding markets.

Participants in this roundtable were:

Chris Babington, managing director, head of financial institutions DCM, Lloyds TSB Corporate Markets

Rob Ellison, deputy head of financial institutions DCM for EMEA, UBS

Jennifer Moreland, head of treasury markets, RBS Group Treasury

Mauricio Noé, managing director, head of senior and covered bond funding, Deutsche Bank

Daniel Shore, head of Northern European FIG DCM, HSBC

Sanjay Sofat, head of capital issuance and structuring, Lloyds Banking Group

Edward Stevenson, head of European FIG DCM, BNP Paribas

David Wallis, head of term funding, Nationwide Building Society

Katie Llanos-Small, moderator, EuroWeek

Chris Dammers, moderator, EuroWeek

EUROWEEK: Let’s start with this year’s sovereign crisis. What was the impact on UK FIG financing and has the concern all passed now?

rob ellison, ubs: I’m not sure the linkage is as strong in the UK as it is for other countries. UK financial borrowers funded through the sovereign crisis with a higher degree of consistency than many other European counterparts. UK banks continued to pursue their funding agenda throughout the first half, getting solid deals away, picking their market spots, diversifying into different markets and choosing less market-sensitive transactions, such as the Lloyds US SEC retail transaction, when institutional markets weren’t such a friendly place to be. The issuing pattern demonstrates borrowers who have a balanced view of a funding requirement versus credit spreads. UK banks do trade at the wider end of the rating spectrum when compared against other European jurisdictions but that’s not simply a function of the market’s perception of the credit risk, whether that’s sovereign-linked or not, it’s more a function of borrowers who have continued to pursue their funding agenda. In June the market started to get a clearer picture of the UK political situation and we saw UK sovereign CDS trading through French sovereign CDS for the first time since 2007. Then we had a significant reduction in the ECB balance sheet. In early July we had the stress tests, which were well received, and Basel III, which was highly relevant for the UK. These are all positive signals and should have driven a substantial tightening of UK financial borrowing costs. However, it was only coming into September that we started to see UK FIG spreads significantly outperforming their European counterparts. Some of that delay has been the same delay that’s affected all credit spreads, which has been that the market spent August obsessing about ‘will we, won’t we’, double dip. As we’ve emerged from that and the market has got more comfortable with buying credit, then the UK has had this kind of delayed halo effect which has been to everyone’s benefit round this table.

Chris Babington, Lloyds TSB Corporate Markets: There’s been a perception earlier in the year about significant supply from the UK. There’s a number of factors why the supply hasn’t been as large as expected — in terms of building up liquidity portfolios, balance sheets haven’t grown as quickly. If GDP increases significantly, then there’d be more to do, but generally the UK has been very aware of how to manage its funding requirements, and I think we’ve actually managed around the funding gaps pretty well. We’ve opened up a lot of new markets. We’ve had a lot of new programmes going in. We haven’t seen people coming into the market and printing irresponsibly. We’ve seen people pick their spots.

The perception was that issuers had a lot more to do and the reality has helped push spreads in, and the number of investors coming into transactions has been very encouraging as well.

Ellison, UBS: If we were to characterise investor perception of UK banks in the first half of the year, it was dominated by an inflated understanding of just how big the funding agenda was. Staying engaged with new issue markets in the first half got UK borrowers into a good position in August, which came on the heels of all the other good news, particularly NSFR. Combined with very active ongoing management of investor perception, borrowers have been able to demonstrate that the perceived mountain that needed to be climbed was actually more of a hill, and these issuers are close to the summit already.

Sanjay Sofat, Lloyds Banking Group: From an issuer’s perspective, the one thing that we’ve been doing on our side is a lot of investor work. The messaging around Lloyds in the context of the UK takes time explain and it’s a virtuous circle. In addition, the coalition government came in and made strong noises about reducing the budget deficit. It’s done exactly what the markets outlined it should be doing. That has all helped the halo effect, but the reality is that we fund through the cycle.

We are lending banks and we have to have access to the markets. And, yes, it’s nice to be able to diversify where the opportunities allow us, but we are pretty consistent with the message that goes out, which is that the UK banking sector has been through a period of rehabilitation, and we think we are coming out of it.

It’s no longer a stigma to be a UK bank out on the road and talking about the opportunities that face the new Lloyds Banking Group. Questions from investors are less about UK plc and sovereign risk than they used to be. The focus is more about the improvements we have made and the positive things we are doing with our businesses.

Babington, Lloyds tsb: I think some of the fear has also disappeared. If you look back, last year obviously there was a lot of turmoil, but there was also other factors that came in, for example, like the Banking Act, which perhaps gave investors a bit of concern as to what was going to happen in relation to capital. Those factors have moved away, so we’re in a completely different space. Concern over the UK market also dissipated in line with the banks recovering at the same time.

Edward Stevenson, BNP Paribas: The bank results are key, because I wonder whether the UK banks were hit as hard as some other jurisdictions on the sovereign crisis. French banks, for instance, really suffered during the sovereign crisis with exposures to Spain and Greece and Italy, etc. But what’s really changed in the UK market is that the stronger half year results from Lloyds and RBS have made a real difference, in terms of secondary performance since August and September, and now that’s moved down to some of the smaller institutions. In the last week, we’ve seen some of the smaller mutuals and building societies being able to access a market for the first time in probably two or three years on the senior unsecured side.

David Wallis, Nationwide Building Society: That’s right. Throughout the past six to nine months, there’s been a drift away from the uncertainty to incremental certainty with results and there’s the whole macro thing fading away to some extent. You now spend 25% of your time talking about UK plc and 75% about the specifics of your credit, whereas that balance in the last six months was very different. The government has got hold of the deficit, they’ve signalled positively. We’ve now got Moody’s affirming the UK. We’ve always had the independent currency angle sitting there, so the UK has benefited to a smaller extent in that big picture macro discussion.

Jennifer Moreland, Royal Bank of Scotland: In addition to the investor marketing point, the other key prong to our strategy has been diversification. The sovereign crisis, in particular, provided validation of the fact that diversification is very important. It was a reminder that the markets are not always going to be open, and that they’re not always going to be shut at the same time. Certain ones will open before others. That’s certainly been the strategy we’ve been following at RBS, and I’d venture to say that it’s similar at the other organisations as well. You have to make sure that you’ve got access to as many markets as possible, because you’re never quite sure which ones are going to be open at competitive levels for you.

Babington, Lloyds Tsb: That’s a key point as well in terms of issuers’ perception and how they actually do things. We’ve moved a long way in terms of not being prepared to take the first step forward. Treasuries have become a lot more adventurous, a lot more forward looking in how they’re actually going to deal with markets. They’re prepared to deal with higher spreads, with the work going into accessing new markets, and they’ve invested in investor relations.

EUROWEEK: Why do you think UK issuers have been more willing to do that sort of ground testing, to access all these various markets, even if they may have to pay up sometimes, compared with issuers from some other jurisdictions? Is it just a question of necessity?

Wallis, Nationwide: I don’t think it’s a question of paying up. It’s a question of a positive engagement of the investor base. To some extent I’m not sure that’s very different. I don’t think issuers go out with the concept that "I will do a transaction in a currency at a maturity". They’re much more open-minded, and when you go out with an open-minded approach to the investor base, you quickly find a decent sweet spot and that enhances the whole execution process.

Sofat, Lbg: Flexibility, that’s the key. For us to go back to our treasurers without options is pretty much a non-starter these days. It’s also putting a bit more pressure on our advisors to work with us in coming up with more solutions. With the best will in the world, you can have access to every funding programme possible but it’s up to you to pinpoint the execution that achieves your goal.

Daniel Shore, HSBC: If you had this conversation with other jurisdictions, where there is no option to diversify beyond your core market, there’d be a pretty short answer, so that’s the good thing about the UK. Investors globally will look at UK credit and say, if you have aspirations to run your capital liquidity in an efficient manner, you have to look at what the opportunities are. So I do think relative value can change day by day, and it’s not about paying up.

A couple of very interesting transactions this year have been from Lloyds, one being the retail deal which got sold in the US and Asia and more recently a 30 year sterling issue. You could almost argue that this deal was a new asset class for sterling investors because of the duration. They’ll have a certain amount of credit for each issuer but investors looked at this totally differently because they were desperate for the duration. They put a "new" credit line aside for that deal, irrespective of the credit now outstanding to them in the Lloyds name. So a global funding strategy is the right way forward, but a lot of issuers don’t have that ability outside the UK.

Stevenson, BNP Paribas: Lots of jurisdictions are looking at different funding avenues. The Nordics, for instance, are focused on commercial covered bonds, and/or setting up public sector covered bond programmes, so it’s sort of a global avenue to try to look at as many different funding options as possible. Whether it’s accessing retail in Europe, US or Asia, it certainly makes sense.

EUROWEEK: How would you characterise investors’ criteria towards senior unsecured debt, and how has that changed? Is there concern about a lot of refinancings to come in the next couple of years?

Stevenson, BNP Paribas: The biggest concern around senior unsecured debt at the moment is the whole bail-in discussion and what’s going to happen in terms of potential haircuts. Will it lead to much more secured issuance in either covered or ABS format? That’s the biggest cloud on the horizon in terms of senior unsecured issuance, because in recent times the market’s improved. More and more real money accounts have decided to come back into the FIG senior unsecured market.

Moreland, RBS: The amount of research and hype that has surrounded the refinancing risk for the UK bank sector and banks in general over the next couple of years is grossly overdone. A lot of the research has not been looking at the issue the way that we at each individual bank look at it. Therefore, research continues to arrive at numbers that sound so scary and so big, and sound as though the market will never be able to absorb it. The reality is we’re all issuing when the markets tell us that there is demand, and we’re not going beyond that. We’re being responsible with respect to the capacity that’s there, and volume is being absorbed. I am concerned about the hype surrounding the refinancing numbers.

Sofat, Lbg: Unfortunately, the Bloomberg DDIS function provides a crude snapshot of debt outstanding and that’s not representative of what’s going on. It’s important to look at the asset side of the balance sheet. People are managing their balance sheets at different paces, have different assets mixes that don’t necessarily require refinancing on a one-for-one basis. Access to the unsecured market is the key. As long as you are putting transactions in the market at the right time, and sizing and pricing them properly, senior creditors are less likely to walk away from them. There is cash available for all of us. We’re not competing with each other. We’re not looking to take cash from each other. Investors are being measured and responsible as well.

Babington, Lloyds tsb: The major concern going forward is that, if senior creditors are assumed to be taking some sort of loss absorption, it does actually change the investor mandates, so the capacity could go down for senior debt, which is a potential concern. Therefore, we are pushed more into the secured space, but that’s obviously uncertain at the moment.

Shore, HSBC: The bail-in question you raised there is global, not UK-specific. It could cause issues for everybody, globally, to have investors looking at subordinated paper with the changes under Basel III, and making that product perhaps not in the mandate for the investors. If you’re going to make senior bonds not the mandates of those investors, then potentially regulators have to think about the impact on markets for the financial world.

Ellison, UBS: In some respects, it’s actually older news for the UK than it is for everyone else. If the question is about senior unsecured versus other products, then the headline for me is that there is a huge growth in the number of investors who are buying senior unsecured from UK FIG. That spans geographies and investor types, whether it’s institutional or retail.

EUROWEEK: There has been talk that covered bonds have played a bigger role this year than they have in the past. What are your thoughts on the role of covered bonds this year and in the future?

Babington, Lloyds tsb: A bank normally issues senior debt in short to mid maturities. The covered bond market gives you a different investor base and enables you to push your liabilities out longer, which is currently a key objective for most banks. So covered bonds fit a lot of buckets of what we’re trying to do for our clients. In addition to extending liabilities they provide excellent diversification, which can again help the underlying credit spreads tighten. The indirect cost of issuing a covered bond does, however, increase as the demand for collateral increases, so the cost effectiveness becomes a much closer discussion again.

Moreland, RBS: That diversification point is the important one for us, and RBS has a different perspective than the other banks do because we’re new to that market this year. So we really were looking at the covered bond market as a way of diversifying our funding base and accessing new set of investors. Hopefully over the years we’ll be able to increase our presence and build out our curve in that market, and rely on it as a stable source of funding. We can then begin to nuance which types of covered bonds we’re trying to do. As I said, that is different than my other colleagues because you guys have been active for longer.

Sofat, Lbg: We have a history of issuing in this market for a number of years. Our platforms are ready and well established with investors. It’s now about trying to access this space tactically, and the issuing windows in that space. The windows seem to be very small and often congested to access the covered bond space. That tells a story in itself about the way the market’s evolved. I guess one fear is that is that every bank will try to build a covered bond platform, everyone will be encouraged to do so, and everyone will try to issue off it.

Stevenson, BNP Paribas: Since the summer the investor base in the euro covered bond market has picked up, so we’re fairly consistently seeing more than just 20 investors in the book, up to at least 50, possibly 100. But what’s also happening is that the duration offered by the covered bond market in euros is increasing, so 10 and 12 years are now on offer, whereas earlier in the year, it was much shorter maturities that were available, three to five years. The other big market that we’re all making a push for is the US covered bond market, where obviously the first transaction last week in dollars opened up the market again. That’s going to be a big area of growth, and one of the key objectives there is to ensure that US investors give value to the collateral and ensure there is a proper pricing differential between senior unsecured and covered.

Babington, Lloyds tsb: What do we think about the sterling covered bond market?

Wallis, Nationwide: My view would be there is interest there. It’s been a long-held European criticism of the lack of domestic bid, which is a bit of a misnomer, really, because no domestic UK fund manager is going to invest significantly in euros anyway. So that’s been a helpful tool for Europeans to use against the UK covered bond market. But now we’ve got the registered framework, and the UK guys are interested in it, and it’s probably got to a point where somebody’s just going to push a button, because it’s going to happen.

Stevenson, BNP Paribas: There’s also demand in Swiss franc covered bonds. HSBC issued Swiss franc covered bonds earlier in the year, and again, there’s plenty of demand there. So these markets are opening up, and currency diversification will be an important play.

Mauricio Noé, Deutsche Bank: For me the interesting dynamic is that obviously we have the big banks around the table, but for the next tier down covered bonds may not make sense from a pricing perspective.

At the ABS conference in the summer, UK and Dutch mortgage risk was referred to as super-prime, and so if you’re a smaller building society with senior unsecured and CDS spreads in the 200s or 300s, actually RMBS becomes a more economic bundling tool for you than covered bonds. So I’m slightly less concerned about everyone issuing too much of the product, because from an economic perspective, for a building society, it doesn’t necessarily make sense to do it.

They still have these programmes with features at the back end, which are not particularly marketable as they are designed specifically to get a triple-A rating to access the Bank of England’s SLS programme. So in terms of actual supply from the UK, I don’t expect it to be ridiculously high and it’s probably only the people around this table. There’s not going to be a whole lot more.

Wallis, Nationwide: We’re all looking at the value of diversification more than ever, of a wholesale funding platform that’s across short, long, currency, secured, unsecured. I don’t believe any of the larger UK issuers would over-issue in any particular market. It just makes no sense.

Babington, Lloyds tsb: Also covered bond pricing versus ABS versus senior, in terms of rationality between the different asset classes, full divisions between the asset classes haven’t completely developed yet, so at the moment it’s putting quite a lot of value in covered bonds as an investor.

Ellison, UBS: The analysis has to be weighted for collateral efficiency and is going to change with market spreads. For smaller issuers it’s a risky strategy just to have one funding tool. And if that one funding tool is RMBS, given the concentrated nature of the investor base in that market, then as a negotiating proposition it’s not ideal. Maybe we’re a little bit early to dismiss sterling covered bonds, maybe the Solvency II rules will point very clearly in that direction. We have a domestic investor base dominated by insurance companies. The way they measure and allocate capital is changing in favour of covered bonds over other credit products.

I remain hopeful on behalf of those smaller issuers, who probably do need more than one funding tool at their disposal, and those larger issuers that have to bear the costs of swapping offshore covered bond issuance. For example, Nordic issuers have an extremely loyal domestic investor base with highly rational markets that will take down their covered bonds in size. Why can’t the UK have a similar avenue?

Noé, Deutsche: That’s very interesting. You’re right, Solvency II favours covered bonds. The capital charge is 0.6 times the credit spread, which is far better than any other credit product. In Basel III we’ve got a 15% haircut in covered bonds in the liquidity covered ratio, and 40% is the maximum holding of non-government assets in the liquidity buffer. But that should give bank treasuries the ability to buy this product and hold it as regulatory liquidity. The FSA needs to also adhere to that to promote the product in the UK. The previous regulation only allows you to buy Gilts but one would hope that the FSA broadens it out and recognises that by doing this they’re not only improving the carry position for the banks, which is obviously the main reason why the rule was postponed, but they’re also helping develop the covered bond market.

Babington, Lloyds tsb: These are big steps for the regulators, Bank of England etc, because they’ve never even accepted agency paper so to take a step forwards and take covered bonds is quite big.

Wallis, Nationwide: I have some doubts. It doesn’t feel like they’re prepared to make that step. Now, whether they could encourage it in a variety of ways, I don’t know, but it just doesn’t quite feel like they’re going to get there.

Noé, Deutsche: Something needs to give in terms of the liquidity buffers. Clearly they have proved to be very expensive. Holding a truckload of Gilts is expensive, particularly at the moment; it’s got even worse following the recent rally. So something’s got to give and one would hope that this would be an elegant way of dealing with it.

Wallis, Nationwide: Yes, although my sense is that the UK regulator feels uniquely the impact of the crisis and intends to act slightly more conservatively than what we’re seeing out of other jurisdictions.

EUROWEEK: What are the other key areas where the FSA has approached Basel III or indeed some areas around regulatory issues differently from other European regulators, whether it’s on eligible capital or other aspects?

Sofat, Lbg: The FSA has a fiendishly difficult task. It’s as simple as that. They are absolutely critical to the success of the UK banking model. The FSA, working with the Bank of England, HM Treasury, and I guess in certain instances with major shareholders like UKFI, are important voices in the regulatory debate.

I believe the FSA is trying to offer us a level playing field and is working across jurisdictions to do that. Unfortunately, some of the recent statements and press releases from the BCBS have not been as clear as they could have been. While we actively engage in the Basel III debate we look to the FSA, its prudential rule book and the existing legal framework under the Capital Resources Directive for direction. That’s pretty much the starting point for what we can and can’t do. Fundamentally we have to satisfy our national regulator that what we issue is fit for purpose.

Stevenson, BNP Paribas: It will be interesting in the next couple of weeks to see across Europe which banks and which jurisdictions issue subordinated debt, because there’s plenty of interpretation of the rules at the moment as to whether things will be or won’t be grandfathered. And I think some regulators have more liberal views than others.

Sofat, Lbg: The spirit of Basel is to create an even playing field and any uncertainty will not help this. Whether you’ve issued now or intend to issue, if you are looking at the subordinated markets for refinancing, what you’re looking for is an element of clarity.

EUROWEEK: On that front, what’s it going to be like as you go through the transition into Basel III? You have the new Prudential Regulatory Authority in the Bank of England, you also have the European supervisory authorities on top of that, or alongside, depending on your point of view — how do you see that interaction playing out in terms of the transition to the new liquidity and capital frameworks?

Shore, HSBC: It’s going to be complex, no doubt, because if you think about the number of institutions and organisations you’ve mentioned, plus you then look at the other side of the fence of what would be best it’s a fine balance with a lot of parties inputting into it. The regulators are mindful of those implications. For the UK, it’s slightly different in some respects because it has a large mutual sector, which is very important. And without the access to pure equity, obviously there’s a different outlook in terms of how you capitalise those institutions. So for the UK there are a couple of different things versus the rest of Europe and the world but ultimately it is a complex process.

Babington, Lloyds tsb: If you look at the number of papers that are coming out, we were in different consultation phases with different answers to go back at differing periods. And in between some of these times, other papers are coming out from the various bodies out there which need consultation and feedback. It’s a very difficult scenario both from an issuer’s side and the debt capital market side, as well as an investor side. So there’s a bit of confusion out there. We’re in a period of moratorium to a certain degree.

Noé, Deutsche: But talking about the level playing field, it actually makes it even worse because it favours the stronger banks. Look at Nordea coming out with a lower tier two today (mid-September) with no regulatory call and just a 30bp differential between senior and sub. They can afford to do that, they can have a punt. For 30bp, it’s worth it. But for most banks, if the senior/sub differential is 200bp, you can’t afford to do that. So it makes the playing field even less level.

Sofat, Lbg: And I don’t think that’s what Basel wanted. I hope that they offer some clarification statements. Without clarification, individual banks and regulators will issue in a vacuum and that will just create more confusion on what product and structure is acceptable.

Ellison, UBS: The regulatory bodies have been tasked with making sure we don’t have another financial crisis. That’s a big job and if anyone is expecting that to be a clean, smooth, totally transparent, easy to understand and deal with process, then maybe we are a little bit over optimistic in our expectation from that and we have to bear with them.

EUROWEEK: On that point, if we come back to the idea of bail-ins that we touched on earlier, are they the way forward? How would bail-ins change the shape of the UK FIG financing map?

Noé, Deutsche: You can see the positives of bail-ins and the negatives and there’s been very little actually publicly stated on it. The first time it was mentioned publicly was in the context of systemically important banks, which was a new angle, a new trajectory for the topic. Everyone is trying to work out, as you mentioned before, whether the product would fit within investors’ mandates.

The previous iteration, if it applied to everyone, would polarise the funding markets — the big banks, where a bail-in was less likely, would fund a lot better than the smaller banks where a bail-in was a more likely scenario. I guess this new nuance that it only applies to systemically important banks does the exact opposite, and levels the playing field potentially.

One concern with it would be that politicians may be of the mind to level the playing field given situations like Lloyds or JPMorgan, where competition law has been set to one side in order to stabilise the financial system — they may feel that this is a clever way of levelling the playing field. We wouldn’t agree with that necessarily because the senior unsecured product, in particular, is the bread and butter funding product of a bank. And if you add another layer of net interest margin erosion to the whole regulatory landscape that impacts banks’ earnings and lending capacity. The whole bail-in for senior debt needs to be put into context with everything else that’s being layered on top of banks at the moment because banks need a positive net interest margin.

Wallis, Nationwide: Many investors felt that senior was a much safer investment than sub and this fundamentally challenges it. But it’s too early there to say.

Moreland, RBS: As a concept, at RBS, we’re generally supportive of the idea of loss absorption on capital instruments as it was recently proposed by Basel: something that will extend up from tier one to lower tier two. We are interested to see how that develops because we can accept that there needs to be a more orderly system with respect to burden sharing. We recognise that we received taxpayer support and are very grateful for it. Therefore, we are supportive of work to develop a better overall societal solution for another crisis, heaven forbid it should happen again. We are concerned that if the discussion on loss absorption extends to senior debt, the picture changes dramatically and that is an entirely different conversation.

Sofat, Lbg: Lloyds’ position echoes the RBS view. We continue to actively engage in the appropriate working committees, such as AFME. It’s important to note that loss absorbency for capital holders is something that, while not nice, has been experienced by investors and been seen in practical circumstances. Taking the debate about pain to the senior creditors has the potential to impact the funding market and real macro economy. I think the debate will continue to evolve and I think we all want a practical solution.

Stevenson, BNP Paribas: On the one hand, for the stronger banks who trade at tighter levels, the bail-in proposals for senior debt might create positive competitive advantages. But then on the negative perspective, it’s going to push up the cost of senior debt funding significantly for everybody. And it’s also going to reduce the investor base and lead to much higher costs in terms of loans and mortgages for the end consumer.

So the politicians need to think, do they want the taxpayers to pay more for their loans or do they want to be potentially on the hook for a much larger sum if a bank goes under. That’s the discussion and it’s not entirely obvious where the answer lies.

Wallis, Nationwide: I’d prefer to see the capital debate landed and levelled for the mutual sector, bound with the UK banking sector before we get on to another debate.

Ellison, UBS: I agree. Why are we talking about senior acting as capital when we don’t even know what capital looks like?

Shore, HSBC: It was interesting through the crisis how closely hybrid tier one correlated with equity. If you talk about a bail-in product at a senior level, how do you value that as an investor? You’ve got some sort of knock-in put you’ve sold which is almost impossible to value, and when that’s going to come in, it’s going to come in pretty quickly. To sell that product to senior investors is going to be quite difficult.

Babington, Lloyds tsb: I don’t think investors are set up to actually do all the analysis that would have to be undertaken to buy into asset classes that are affected by some of the potential regulations, so it would take longer for investors to react and it would put up the cost as well. So on the cost point, there are a lot of knock-on effects. If anything, investors would probably potentially diversify less because they’ve got to do much more homework, or they employ a new army of analysts to look at the underlying credits. If you look at all the key investors now and also if you go down to smaller investors, they’ve all built up their number of analysts, they’re much more specialised.

Stevenson, BNP Paribas: The other issue is that more than 25% of paper outstanding in the European bond market is bank senior debt, so any potential haircut on that has a huge impact in terms of the investor base. And the other thing to be aware of is that a number of the investors who are buying senior debt are actually managing money on behalf of retail accounts, whether it’s in France etc. So it’s all very circular.

EUROWEEK: To what extent does RMBS form a part of UK banks’ funding repertoire at the moment? What are its main advantages or disadvantages compared to any other forms of secured funding?

Wallis, Nationwide: One of our responses to the crisis was to bring on a securitisation capability. Some may feel, given its headlines during the crisis, that this is an odd response from a mutual, but for us it’s about extending that diversification and funding platform. We see the securitisation markets as an additional string to our bow. We don’t see that changing. We’ll look to use it sensibly. The way it’s developing currently versus some of the other markets is a little slower. There have been a few more bumps along that particular road. I would expect it to be a significantly slower burner. With that said, it is heading in the right direction. We need a few more transactions working substantively.

Shore, HSBC: If you think about the major buyers of RMBS pre-crisis, it was the SIVs and they’ve disappeared. Some other investors who were there pre-crisis are still there now. The requirements change across a lot of the investor base and other people will look at the asset class but I agree with David about it being a slow burner. With the UK banks being able to access covered bond funding then you’ve got a different investor base there for funding the mortgage market. The RMBS market is a good choice to have and it will be interesting to see how quickly it develops over next six to 12 months in terms of volumes.

Wallis, Nationwide: There are fundamentally fewer investors in the RMBS market today versus the covered bond markets and that may well prevail going forward. I’d be delighted to see those RMBS investor numbers creep up to the covered bond levels but I fear that they may not.

Ellison, UBS: If the problem with the bank term funding markets pre-crisis was that it was essentially banks lending to banks, then to a greater or lesser extent the epitome of that was the RMBS market, whether it was banks buying direct or through their SIV vehicles. There’s nothing wrong with that because banks were best equipped as investors to analyse what it was they were actually buying. But that means that we shouldn’t be surprised if the RMBS market is the one that’s taking the longest to rehabilitate or mature.

Moreland, RBS: We’re in the market now with a large RMBS deal and it is the first public one that we’ve done since 2007. From an issuer’s perspective, it’s another tool in the toolkit. It would be lovely for the foreseeable future to optimise issuance from among all of our unsecured products, and a whole array of secured products and make our decisions based on which markets are open, which ones seem most competitive in terms of pricing, and to shape that around our funding need. Hopefully the RMBS market will be open enough to allow us to view that as a choice.

Noé, Deutsche: As a funding tool it’s actually rather efficient in comparison to covered bonds. It probably doesn’t really apply to the group here because the larger banks need to mobilise all markets for diversification and to get their funding programme done. But for smaller guys the spreads are very close to each other and probably tighter for RMBS for a small building society, for example, than a covered bond. Adjusted for asset efficiency, RMBS starts to look quite interesting, particularly as the rating agencies’ methodologies for covered bonds are changing. That’s not a very controversial thing to say. It’s harder and harder to get a triple-A rating whereas with RMBS it’s seemingly pretty easy particularly with the arrears data that the UK is enjoying at the moment.

EUROWEEK: Is RMBS a potential way, until the US cover bond market develops, for UK issuers to access dollar investors?

Wallis, Nationwide: Yes, we will be going down the flexible route with all the options open. Some are quicker to market than others. Printing a senior ticket, the speed to market is short; printing an RMBS ticket has a significantly longer lead time.

Babington, Lloyds tsb: From the investor point of view as well it doesn’t form part of the main lines with most investors so from a capacity point of view it’s a useful tool.

Stevenson, BNP Paribas: The US covered bond market will develop. On the Barclays trade last week there was obviously an overlap of senior debt and RMBS investors but there were also a number of people who did give the collateral some credit and the pricing vis-à-vis euros was 10bp through where a euro covered bond would price.

Wallis, Nationwide: There were 50 investors in that book. That bodes well for the dollar covered bond market.

Moreland, RBS: Your question is a little bit "the tail wagging the dog" there. We’re not looking to secured products as a means of deepening our investor base in dollars. That’s not the end goal. We are generally looking for new investors to invest in bank debt; all of us are. So to the extent that in the dollar sector there are some new investors who are brought into the fold because they prefer a secured product, fantastic. That’s what we’re hoping will develop further than it already has.

EUROWEEK: How much potential is there for other asset classes within securitisation from UK financial institutions?

Noé, Deutsche: The appetite for other asset classes is reasonably good, particularly for short dated assets like autos and credit cards. I don’t think anyone’s found the need to do them so far but I suspect the market appetite would be there. For more esoteric and longer dated assets it may be more challenging.

Wallis, Nationwide: You’re right. Credit cards and autos are naturally going to be the first thing that people like myself look through but with some of the specialists or shipping I just don’t think it’s going to happen.

EUROWEEK: How do you think the market’s going to evolve to the end of the year and next year? Are you optimistic? Is there anything you’re worried about it?

Wallis, Nationwide: I’ve been positively encouraged over the past weeks by the amount of supply that’s come to market and how it’s been absorbed. The pre-summer fretting around market snapping shut following a wealth of issuance has proved not to be the case. There’s certainly been plenty of issuance but everybody’s been pretty constructive around it. I would encourage all involved from both my side of the fence and the banking and the investor side of the fence to ensure that all transactions are conceived and executed responsibly. The more all of us do that across all jurisdictions, it can only be beneficial for all concerned. It’s just another building block in establishing permanently open markets for all concerned in all formats.

Moreland, RBS: I agree. I’m very encouraged by the fact that the markets across the product spectrum as well as globally have been absorbing such significant supply and are still performing very well. However, we do have long enough memories to realise that the volatility is going to be with us probably for the foreseeable future, and we are going to have periods where all or many markets are shut. It’s just something that we’re all planning for and managing.

Noé, Deutsche: There’s this background sovereign noise that’s happening, whether it’s Ireland or Greece or wherever, whoever’s in the spotlight at any given moment, but the credit market’s continuing to function and that’s really a change that has evolved in the last six months. We had this Irish auction today, which went well, and still the market’s functioning, there are deals in the market. SNS launched a 10 year covered bond this morning and Nordea a lower tier two, before the Ireland auction, so things are very different. We’re not coming to a standstill, having to reopen the market each time with the double-A national champions and then moving down the credit coverage every time the market stops.

Ellison, UBS: August was a big month for UK FIG. It was palpable that many investors updated their views of what it meant to buy a UK bank or building society bond, whether it’s in terms of how those businesses have performed and the shape of the balance sheets, whether it’s a perception of sovereign risk or whether it was actually the market refreshing its appreciation of how much funding needing to be done by the sector. On that basis I think we deserve to be more optimistic. What I hope is to hear fewer investors saying they will only buy national champions. I also hope it means we can say goodbye to soft sounding. What a dismal process that used to be.

Moreland, RBS: Absolutely.

Noé, Deutsche: One thing you don’t get in the FIG sector is issuers capitulating and issuing at crazy levels. Banks generally don’t fund outside their net interest margin. They go to the ECB or equivalent. There are plenty of banks that are locked out of the market at the moment so it’s not all rosy. However, those guys aren’t going to come to the market with a deal at a crazy spread that’s going to drive the whole credit market wider. You’re only seeing guys coming to the market that can come at economic spreads and that’s hugely important. Market conditions are good but there’s not that much supply actually. I’m presently surprised by how little supply there is in the market. It’s very constructive and it means that hopefully the market will stay open for longer.

Shore, HSBC: We’re cautiously optimistic for the UK sector. Once you see the global macro picture with the sovereign noise, that obviously can affect access to markets and the performance of the economy and impact the sector, but the UK financial sector is well capitalised and it’s fairly liquid. That’s how we got to our cautiously optimistic view for the next 12 to 18 months.

Stevenson, BNP Paribas: I’m going to strike a note here of slight caution. On the one side it’s positive that we’re getting the second tier names, mutuals such as the Coventry Building Society or the Cooperative Bank etc, having access to market when over the last 18 months that hasn’t always been possible. But I would be amazed if there’s not some kind of macro event before the end of the year which suddenly shuts the market down for a while. It’s almost been too rosy for too long.

Noé, Deutsche: We’re certainly more resilient, though. We’re almost at the wides in the periphery. Ireland was trading at something like 430 in five year CDS yesterday.

Moreland, RBS: In general we’re all feeling reasonably comfortable. We’ve made hay while the sun was shining and so now we are braced for the fact that a macro event could happen again before year end.

Babington, Lloyds tsb: The market seems actually very good at absorbing what’s gone on in terms of news shocks. It almost reinvents itself and moves on again. Obviously there’s an awful lot to be reinvented in terms of capital but the market hasn’t shut down on a consistent basis like it did before.

We’re all a bit more aware of exactly what’s going on and what the concerns are out there. The co-operation between parties has been far greater than it was before, which is a factor in trying to be responsible for the markets. There’s an awful lot of perception and hype that hasn’t come to fruition. A lot of other factors are going on like balance sheet reductions, as opposed to just purely the funding side of things.

While the issuers have done a lot of funding, they’ve regained their capital status to a certain degree and we have a whole set of regulations coming forward, whether it’s capital, accounting or moving derivatives on to central exchanges. There’s an awful lot of work to be done but the backdrop is a lot more positive than it has been for an long time.

Ellison, UBS: Maybe there is a big macro event around the corner but it’s clear that we’re a lot better tooled up to deal with one should it come. The way our institutions work and the way our investors perceive us, particularly in the UK, we are much better positioned to face those challenges than we were two or three years ago. A lot of that’s down to experience, to do with funding through the cycle, pursuing investor diversification, opening the channels, all of those things.

Stevenson, BNP Paribas: I have to say it will remain choppy. It was only four months ago that we didn’t do a single bond issue during May at all. Because of the sovereign crisis there was very little access to the market for anybody and that could easily come about again.

Shore, HSBC: You’ve got that backdrop, which is dictated by sovereigns and the global macro picture. But the UK’s started the whole conversation by saying people are looking at the UK credit in a more positive light compared with two years ago when they were saying the whole financial system in the UK was going to collapse.

We can’t get out of what’s happening outside, the issuers can’t control that. But what they have done, what the regulator’s done, is put in the hard work over the last couple of years to position the issuers with investors to access those markets when they’re open.

Wallis, Nationwide: The volatility, the peaks and troughs, are going to be narrower. So the range from there is now down to here because even if you hit those bumper levels now, then you look back and go, okay, RBS or Lloyds or Nationwide have done X number of senior sub and structured trades in the last 12 months, therefore that chunk of funding is better off than they were two years ago.

Noé, Deutsche: The sovereign noise isn’t going to go away in a hurry. The real reason why the sovereigns are trading so wide is that parts of the market expect a restructuring from the peripheries and that’s not going to go away for a few years. It’s going to take a long, long time for that to dissipate and that’s why these bonds trade in a distressed manner because there’s a view, ill-informed in my opinion, that an orderly restructuring is the way to address the issue.

Sofat, Lbg: My view is that there will continue to be a degree of uncertainty until the new regulatory framework is enshrined in national law. At Lloyds, we got to where we wanted to be relative to our funding plan around late August. That’s a good position for us to be in. There’s no complacency in trying to pre-fund as well, which is a question we frequently get asked. We will continue to be measured and look at opportunities where these arise. The other thing we noticed, just looking at the deals we’ve done this year, is investor behaviour. Until recently it was a common theme to see one or two very large orders skewing a book and really putting an issuer in a difficult position with regards to how they best manage their transaction. The granularity and diversity we see in all our recent trades has been very positive.

Wallis, Nationwide: Particularly in senior books. You do see a very significant tail these days and that’s actually quite helpful in the secondary performance piece because you’ve got that continual retail bid.

28 Sep 2010