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Bank funding: back to normal, but everything’s different

After several years of crisis, the bank funding markets are finally beginning to normalise.

But things look very different these days. Central bank liquidity measures, deleveraging and the resulting lack of benchmark supply have all pulled spreads tighter, but banks cannot take advantage as they simply don’t need as much funding as they used to. However, having built up an arsenal of funding weapons during the crisis, issuers don’t want to let go of them just yet. To discuss the challenges facing bank treasurers, EuroWeek brought together leading bank issuers at the Bank Finance Issuer’s Roundtable in September.

Participants in the roundtable were:

Waleed El-Amir, head of group strategic funding and investments, UniCredit

Peter Green, head of senior issuance, group corporate treasury, Lloyds Banking Group

Philippe Hombert, global head of debt capital markets for financials and public sector, Natixis

Bas Iserief, head of long term funding, ING

Rainer Mastenbroek, head of covered bond funding, Commerzbank

Will Caiger-Smith, moderator, EuroWeek

EUROWEEK: How have issuers’ funding requirements changed over recent years and how does that affect your supply of senior debt and your relationship with investors in that space? 

Peter Green, Lloyds Banking Group: We need to consider that question in the context of the market. From a UK perspective, the context is one of bank deleveraging, regulatory change and macroeconomic headwinds that have led banks in a certain direction. We have seen a rebalancing of our wholesale funding requirement, in the sense that wholesale funding volumes have come down, both in the short end and in the term funding space. 

To put that into context and give some numbers, Lloyds’ funding requirement in 2010 was around £50bn. It was down to £35bn in 2011. Last year we started with a funding requirement of £20bn-£25bn but because of improvements in the balance sheet, central bank liquidity schemes and less of an impact from ratings actions, we had surplus liquidity and we conducted a number of public buyback exercises. 

In 2013, we started with a funding requirement of almost zero. We’ve executed more buybacks and repaid LTRO. For 2014 we are expecting to have modest funding needs and from 2015 we’re expecting to have a steady state funding requirement that will be much lower than we’ve had before.

We need to look at the drivers of this reduction and it’s very much been because of transforming the balance sheet immediately after the HBOS acquisition. The group made a number of strategic decisions such as balance sheet deleveraging, non-core asset reduction, building up strong liquidity buffers, to the point that we went into the second half of 2012 with excess liquidity. We’ve seen a very deliberate increase in deposit flow. We were really looking to reduce the loan to deposit ratio, which had been considered to be too high, and we’ve seen good progress in getting the core loan to deposit ratio down to 100% at the end of the first half of 2013. 

We’ve also got to look at it in the context of the central bank liquidity facilities that have been available to banks. In 2012, it was the LTRO. The year 2012 also saw the introduction of Funding for Lending in the UK, again contributing to lower wholesale funding requirements for UK banks. At Lloyds, we haven’t accessed the wholesale funding markets in the public space since March 2012. Generally, market supply of paper has been lighter. Other banks across Europe have also been looking to deleverage. Maintaining relationships with investors is a unique problem. We’ve spent a lot of time and effort diversifying our funding sources in previous years, so we’ve got lots of access points that we need to maintain across the globe. 

The way we interact with investors has evolved. We’ve always been active in our global investor relations effort, and that has continued. Even though we’ve got a limited amount of funding to do this year, we do think that maintaining that interaction with investors and those access points will help us in the long term. At the point that we do need to re-enter the wholesale market, that interaction with investors is one that we will be able to pick up very easily, without having to do a huge amount of credit work with the investors we engage with. 

We engage with investors at roundtable events, conferences, and one-on-one meetings. We’ve also continued to print private placements. That’s been a constant source of funding for us. That’s not a tap we want to turn off. Investors want continuity in the private placement space and that’s something we’ve had a reasonable amount of success with. 

EUROWEEK: Bas, how does that compare with your experience at ING?

Bas Iserief, ING: Very similar, but less bipolar. Since 2007 we’ve been making the balance sheet a little safer with long term issuance. Since then, we’ve been issuing something like €20bn-€30bn each year, more from a risk management perspective than anything else. We’ve also had a case of certain pockets of trapped liquidity. That has made it essential to do some asset transfers, because we could not transfer the liabilities. That is interesting because then you have to rebuild the business, rebuild your risk management, and replicate it in another country. We cannot centralise that effort. 

We’ve been trying to optimise our liquidity situation in Europe, and we’ve done a lot more long term funding than we had previously done. But now that our balance sheet is sort of repaired, asset growth has become a point of focus. We’re trying to monitor this very closely. We have room to grow our balance sheet. But while the money might be available, if people don’t take it you run into rather limited asset growth and fairly short duration of assets. 

As a result of this, we found ourselves slightly over-funded at the end of last year and therefore we have significantly reduced our funding for this year. In terms of investor relations that is actually quite good, because it means we have the time to meet our investors. They will always maintain interest in your credit story. There’s a story to tell about ING, and we’re moving in the right direction — we’re not too far from being back to a normal state of banking and that’s a good message to bring across. 

So in terms of funding, we’re hitting the brakes slightly this year and getting back into normal operating procedure for next year. 

EUROWEEK: And, Rainer, how does that compare to Commerzbank?

Rainer Mastenbroek, Commerzbank: It’s no surprise that the situation with us is similar to what has just been described. By chance, I just came across a document from before the crisis with which we were presenting our funding plan for the next year to an internal committee, and at the time we had a funding plan of around €35bn. That is not that long ago, but we are far away from that figure now, despite having more or less the same size balance sheet. At the time, we had a lot of wholesale funding on board — not least because of Eurohypo and its huge covered bond programmes.

Then came the takeover of Dresdner Bank, and combining the two client franchises allowed us to rely more on retail and corporate deposits. So our wholesale funding needs have come down significantly. Also, of course, because we deleveraged after the Dresdner acquisition, having had a balance sheet of more than €1tr after it took place, we’re now back at around €650bn. Last year we only had to issue €4bn in the capital markets, and this year it’s similar.

In the coming years I expect it to be slightly more because we will have established three new covered bond programmes by the end of 2013. We already issued an SME structured covered bond. We issued our first public sector Pfandbrief this year and we’re just in the final rounds of establishing a mortgage Pfandbrief programme as well. So we’re going to use these programmes in the years to come, of course.

But on the senior unsecured side things are going to remain as they are at the moment, with limited requirements. We can basically cover our issuance needs via structured notes and plain vanilla private placements, which are mainly issued to the clients of our investment bank. So going forward there’s going to be a mix of covered bonds which we will place mainly in the public markets, and senior unsecured private placements.

Investor relations work is still very important to us, though. On the one hand we have a huge amount of instruments outstanding, like all the covered bonds of the former Eurohypo. We have a benchmark curve for Commerzbank in senior unsecured as well. Plus we want to establish all the covered bond programmes. As we all know, covered bonds are not a rates product anymore but the credit of the issuer is important and investors want to get regular updates on that.

EUROWEEK: Waleed, you’ve been at UniCredit for about 10 months now. How’s your experience been there in terms of funding?

Waleed El-Amir, UniCredit: I think it’s divergent, because we run several different businesses as liquidity self-sufficient centres. Our German business is funded in a very similar way to Commerzbank. We basically do one covered bond a year in the public markets and that’s it, the rest is all funded through private placements. Initially, as Peter alluded to, we focused on bringing down the loan to deposit ratio and deleveraging, but we’ve actually still been pretty active in the market. We’ve taken the opportunity to build up our liquidity buffer as we’ve decided we want to have a very strong liquidity position. 

We’ve had a difficult macroeconomic backdrop in Italy and what we’ve been able to tell investors is that as a management team we’ve done everything we need to bolster the balance sheet. We did the rights issue, we increased capital, we increased liquidity very significantly within the bank and we cut costs, so once the macroeconomic backdrop begins to turn, we should see better profitability from the bank. 

So we’ve been relatively active in the wholesale markets this year and our funding budget for the last couple of years hasn’t really changed from about €30bn a year. We’ve done three covered bonds already this year, out of the Italian entity. We’ve done a couple of senior deals and we’ve probably got more to do between now and year end. 

EUROWEEK: What markets and currencies would you say offer the best opportunities? 

El-Amir, UniCredit: We’ve been relatively myopic in terms of how we’ve been addressing our funding. We’ve been focused on euros. The 144A market, which most investment banks pitch to us, is the wrong market for us. They still don’t understand our credit very well, and to my mind there is no pricing benefit. We saw one of our fellow banks go to that market — they spent a year and a half watching that market, and then they hit the trade right where the arbitrage between euros and dollars was flat. Since then it has traded 40bp-50bp back. So it doesn’t make any sense, and the documentation is quite painful. 

We don’t really have any need for dollars, so we’re pretty focused on the euro market and that has been sufficient for us. One of the main reasons for that is that we have a significant advantage compared with a lot of other European banks. We have a retail network into which we can pump quite a lot of senior unsecured or capital, so we use that as a relief valve. If the wholesale markets are a little bit difficult, we basically issue into the retail market. So we generally haven’t diversified. We did a Singapore dollar deal this year in lower tier two, just to get to the Asian investor base, because earlier in the year the private banks were very active. They’re less active now, but we just wanted to get transactional with that investor base. 

But we’re very focused on euros. I think the market has evolved enough and is deep enough for us not to have to do trades in other currencies. We don’t really see the arbitrage, to be honest. 

EUROWEEK: Philippe, what different funding markets — covered bonds, senior, private placements — would you recommend to issuers?

Philippe Hombert, Natixis: I agree with what Bas said about being back to a more normal situation. If we were having this meeting a year ago, for instance, we would have been in a completely different situation, but now we are back in an issuers’ market rather than an investors’ market, and the evolution of spreads clearly illustrates that. This is the main difference compared to last year. When we meet issuers now, all of them are very relaxed about their funding programmes, they feel comfortable. They are not necessarily nervous about their ability to raise funds anymore but they are focused on other projects, like management of their leverage, liquidity and capital ratios, and optimisation of their debt structure. This is an important evolution. Because of deleveraging, because of government support schemes, because of the fact that production is going down, there is less pressure on funding.

In this context, where issuers can take time, and can select what they need in terms of maturity and so on, the privilege is to go to the senior unsecured market, which is more volatile, and clearly we saw that at the beginning of the year. We’ve seen about €100bn of senior unsecured issued so far in 2013, compared to €145bn in the full 2012, so that shows that the senior unsecured market is attractive. On the other side, we have seen fewer covered bonds this year than last year, partly because of asset encumbrance and because issuers prefer to keep this tool for more difficult market conditions.

So we are more or less back to a normal approach of the market, even if all issuers are very vigilant in the current macro volatility. Also, the current low rates are interesting for issuers and some of them will launch trades to lock in very cheap funding costs.

EUROWEEK: Does everyone agree with the idea that we’re back to normal?

Mastenbroek, Commerzbank: Back to normal means that banks are focusing on financing the real economy, and re-focusing on traditional funding sources like deposits. But in terms of markets we’re not really back to normal. It is currently an issuer-friendly environment, and has been for the last 12 months. It was more or less exactly one year ago that we had Mario Draghi’s famous announcement about doing whatever it takes to save the euro, and since then markets have been very receptive. But on the other hand they are still volatile, and I think issuers are well advised to maintain a sound funding profile to be prepared for the future. 

EUROWEEK: And one of the issues going forward is regulation, which if you look at things like bail-in, could potentially have quite a large effect on senior spreads. Is that something that you worry about?

Iserief, ING: I think the jury’s still out on that one. What we’ve seen recently, of course, is shares going up quite significantly and capital spreads coming in quite far. Senior unsecured hasn’t actually changed that much. Maybe it’s already priced in — because on one hand you could say that senior could suffer a higher loss given default, but on the other hand, the probability of default is significantly decreased, especially when you go forward towards Basel III, leverage ratios and all that. It’s not easy for investors to weigh up all these things and go against the market if they decide it’s too expensive or too cheap. Because there will be someone there at the end of the year saying what were you thinking? 

It’s still a market where a lot of people stick to benchmarks and don’t take large off-benchmark bets. There’s still a lot of investor work that needs to be done. There are some issues that investors don’t really dive into, things like single and multiple points of entry for loss absorption and bail-in. This is very, very technical credit work that needs to be done, and even if it is done and you still have a portfolio manager that at the end of the year is losing performance relative to a benchmark, it’s not as clear cut as it would seem. 

Green, Lloyds: As issuers, it’s an interesting dialogue to have with an investor. I went to a conference earlier in the year where investors were clearly voicing the opinion that they didn’t think bail-in was fairly priced and that they would rather take risk in sub debt, because at least they feel that they’re getting paid for that risk. But I agree with you, bail-in is not exactly new news. It has been around for almost 2-1/2 years, so it’s got to be priced in somewhere. I think what we’re maybe not getting right now is a clear differentiation between different credits, the composition of capital stacks and banks’ total capital ratios. For investors to really value or assess the risks of any particular credit, it does need to get very forensic as to what’s the quality of the capital stack, what’s the protection before the senior debt holder has to worry about taking losses. 

But clearly the regulatory environment is not set. It is still in flux. There are lots of jurisdictional differences. I think we’d certainly argue that the UK is pursuing a strong regulatory environment. Until we’ve got clear definition as to where regulators are going to fall on Basel III and all of the regulatory changes then it is going to be difficult to say definitively whether bail-in is priced in or not. The market technical, mainly the fact that there hasn’t been as much supply and investors clearly have money to put to work, is another factor that skews the pricing. 

Mastenbroek, Commerzbank: I agree with you that the rules are not finally set, especially on bail-in, but I think there’s already a clear direction. Right now we have two proposals on the table for bail-in: the European Council’s version, and the European Parliament’s, and both imply that a strong capital base will be required. 

In the Council’s approach you have senior bondholders and large corporate and professional depositors at the same step of the bail-in waterfall. If these depositors are important to you as a funding source you need to protect them with the layer below them, and that’s capital. 

In the Parliament’s approach you have a general depositor preference so you could argue that depositors have the additional protection of senior bondholders in front of them. But you also have to comply with the so-called MREL, the minimum required eligible liabilities available for bail-in. And under the Parliament’s approach this would only consist of subordinated capital.

From talking to investors, we know that bail-in is at the front of their minds. So it’s not surprising that we’ve seen a lot of subordinated debt transactions this year.

As for senior bonds I can only agree with what the others said. Right now bail-in doesn’t seem to be priced in because of the technicals. On the other hand, if you have a strong capital base and if you don’t rely too much on the wholesale funding market it should still be possible in the future to do your senior funding at reasonable levels.

El-Amir, UniCredit: From our perspective, at the moment the market is basically saying that laying on more capital is not giving you cheaper funding spreads. 

Most CFOs that you debate this with say ‘why should I be raising more capital than I need today if I’m not seeing an effect on my funding spreads?’. Banks that have very big gaps, and run very aggressive RWAs, don’t look great on a leverage ratio basis, and they don’t look great on a bail-in basis. But they can trade much tighter than other banks. So at least from our perspective, the way we’ve looked at the analysis, putting on more capital today is just expensive and not really saving us anything in senior. At some point that will probably change, but today you’re not actually getting rewarded for that from investors. 

EUROWEEK: Do you think that’s because there is so much other event risk out there? That because of that, bail-in is a known fact but it’s not quite on people’s radars?

El-Amir, UniCredit: If you plot sovereign spreads against bank spreads the correlation is super-high. For example, some 35% of my risk-weighted assets sit in Italy. But I trade like BTPs in senior. The BTP goes up, I track the BTP. Investors are less focused on the fact that I have the third largest bank in Germany, it’s almost irrelevant. What matters is where the sovereign trades. And if you do the analysis for the other banks it’s quite similar. 

So people are focused much more on probability of default than loss given default, which is where the whole discussion on bail-in is going. Some of that is to do with investors just not doing enough work to get to the numbers. If you want to actually do the loss modelling, you need to do quite a lot of work and I think it’s easier to say ‘they have this rating, I like them, they make quite a lot of money, their capital ratio is X, and France as a banking system or the UK as a banking system is relatively solid, tick the box, tick the box, we’ll buy it at this spread’.

EUROWEEK: But surely a lot of that has got to do with a fear of being left behind if you’re an investor, because of the supply dynamic at the moment. You almost don’t have time to do the work. You can’t be as discerning because there’s so little supply and everyone’s competing for it a lot more. 

El-Amir, UniCredit: I have some sympathy for that. I was at a conference this morning with around 350 investors and when I was speaking I actually said that banks give out more disclosure than they did three or four years ago. I turned it over to the audience, and asked how many of them actually thought that banks give enough disclosure, and no one put their hand up! So I know for a fact that we put out a lot of numbers, and people just don’t digest them. 

The other problem is with things like leverage ratio calculations. Depending on the criteria there were at one point six different numbers that we were running for our leverage ratio, and we didn’t know which one was going to be right. So either you can put out one number, and it can change suddenly when the regulation changes, or you can put out six numbers, which gets confusing. I think people are giving a lot more disclosure than they did before. 

But there’s a lot of uncertainty around numbers — even Basel III fully-loaded numbers continue to change. All of that is changing constantly and so investors are going to struggle as much as we are.

Iserief, ING: The thing is we are liability geeks here. If you were to look at a CDO, the first thing you would look at is the asset quality. I think it’s very important to take a closer look at that and not just focus on what is bail-inable and how does the capital stack work and what happens if the whole thing goes under. So in terms of asset quality there is still a lot of work to be done on disclosure. If you compare all the balance sheets then there are a lot of numbers out there. We are now so focused on capital funding, all those ratios, that it will be very interesting to see these asset reviews that we will be having going forward. 

Hombert, Natixis: We are facing the same problems with covered bonds in terms of the covered pool. The way some investors are analysing the cover pool is exactly as you said, are we sure they are going into detail on the covered pool, or have they just taken the label of the parent and the country? It’s true that a lot of information is now available but the way it is digested is a key point.

I would like to add something on bail-in. We can definitely envisage that bail-in will have an impact on senior pricing, but as we have said, it is a complex analysis because it will definitely not be a homogeneous impact among issuers. I think one of the key criteria will be the famous 8% ratio, which is the equity plus subordinated debt on the balance sheet. Investors will take into account the ability of an issuer to protect his senior unsecured bondholders and the ability of their government to support banks.

Germany is a good example. When they put bail-in in place in 2010, the immediate impact was a huge widening in spreads on subordinated debt but nothing in senior. Why? Because all investors know that Germany will never let the banks get to a bail-in situation, due to the potential impact on the real economy. So if you have a country with the ability to support banks, then the impact on senior will be limited.

Also, I’m not so aligned with you, Waleed, when you say that investors don’t care about the amount of capital. In terms of the 8% ratio, if the ratio is small and the state cannot potentially support the bank then the impact on senior unsecured could be very important. So, in those cases, it could be interesting for an issuer to increase lower tier two now. It is expensive, but the impact on senior unsecured in the future could be interesting.

El-Amir, UniCredit: I think where we disagree is I’m saying that today the empirical evidence doesn’t point to that. Take the French banks — the market hasn’t priced that in, and I think that’s because of what I’m saying, that investors are pricing probability of default much more than loss given default, which is logical to a certain extent. You shouldn’t be buying a bank that you think is going to go into resolution. People are much more focused on that at the moment, so for me to build up a capital buffer today is quite expensive. There’s a lot of negative carry to have, without any return, just to say I’ve got my 8% covered. 

Also the PRA is saying you need to be at 18%, or 19%, and you’ve got this whole primary loss absorbing capital (Plac) layer. In core Europe there is a big split. It depends whether you call it a gold standard or whether they’ve overstepped the mark. The PRA is putting in these huge capital ratio requirements, almost like the Swiss. With the Swiss you can understand it, because the size of the banking system compared to GDP is enormous. But in France, Germany and Italy, Cocos are not being done for regulatory reasons. Those regulators don’t seem to be pushing to 18% or 19% capital ratios because they don’t think banks need to go to that level, and that’s relatively consistent. The capital hitting the market at the moment is generally not motivated by bail-in, it’s to cover rating agency or cover incoming regulatory requirements. 

Mastenbroek, Commerzbank: This 8% number is going to be interesting with regard to individual MREL requirements for banks, because if the goal is to have 8% of bail-in before any outside help can be given, you have to take into account that once you go into resolution a large part of your common equity will already be erased. So if a regulator looks at it and sets the MREL goal for each bank I think it’s going to be beyond the 8% mark.

El-Amir, UniCredit: It goes back to the MREL number, what is that number going to be? 

Mastenbroek, Commerzbank: Yes, that’s what I mean. Right now everybody uses the 8% as a proxy for MREL. But in reality I think it’s going to be a bit higher. But on the other side I’m with you. It doesn’t make sense to pre-fund capital just to support your senior unsecured spreads, especially when you don’t have that big a funding need in senior unsecured.

El-Amir, UniCredit: The problem for regulators is that for certain banks 8% of total liabilities, not risk-adjusted, is huge. It could mean a 20% capital ratio, depending on what your risk-weighted assets and total assets numbers are. So if the regulators start to talk about accelerating bail-in to 2016, let’s say, or even 2015, that could be a problem.

Mastenbroek, Commerzbank: That’s what the Germans want. 

El-Amir, UniCredit: We’re fully aware of that and are on the record as saying we would like later implementation of bail-in on order to allow banks the appropriate transition period to optimise their balance sheets with respect to these regulations. Having that kind of increase in capital ratios across Europe in such a short time frame can be difficult for a lot of institutions. 

And at the end of the day I think most banks are going to do a cost-benefit analysis — do you raise senior, do you raise contractually bail-inable debt as a layer between lower tier two and senior, or do you just say I’m not doing anything, maybe I can deal with the widening. I’m sure all of us are going to be plugging numbers into our little spreadsheets trying to figure out what that number is and modelling the liability structure on that. That’s what we do — we get paid to reduce the cost of funding.

EUROWEEK: So how do covered bonds fit into all this? Covered bonds are historically a bulletproof asset class. There’s never been a default. So are they the last safe-haven for investors and how are they going to become more important as a funding tool going forward? 

Mastenbroek, Commerzbank: I think covered bonds have already become very important. In the last four or five years nearly all of the universal banks have set up covered bond programmes. Before the financial crisis this product was limited to the more specialised banks, especially in Germany. Peter already mentioned that many investors at the moment are of the opinion that on the unsecured side they are only being paid for the bail-in risk when they buy subordinated debt. So many of them don’t like senior too much at the given spread levels. We’ve met many investors who therefore follow a barbell strategy. They get yield by buying the subordinated debt and counterbalance the risk by buying covered bonds as well. So, yes, covered bonds are a very important instrument.

On the other hand, as we all know there are many discussions about how far you can go with your covered bond funding, especially the theme of asset encumbrance. You have to find the right mix. I think you need to have covered bonds in your toolbox to effectively refinance certain assets. But they cannot be used indefinitely.

Hombert, Natixis: I completely agree. It all comes down to having the right mix and diversification of funding tools. You have to do the cost-benefit analysis of senior versus covered, taking asset encumbrance into consideration, and I think that’s something investors are going to become far more focused on if they’re not already. It’s going to be something that does come under greater scrutiny and certainly there will be a push for greater disclosure around encumbrance levels. But covered bonds will always have a place in the funding toolkit.

In a normal funding year, whatever normal is, we would look at all of the tools available to us and we would look to have that diversified mix across asset classes, currencies, and different investor bases. You want to spread the risk of refinancing. Having a diversified funding base has helped banks through the crisis, but with a reduced funding requirement it’s all about how you adequately maintain all of the tools that are available to you. Undoubtedly covered bonds are going to continue to feature but jurisdictionally there will be differences as to how they’re deployed and the extent to which they’re deployed.

EUROWEEK: Rainer, are there any examples of issuers following that same barbell investment strategy you were talking about? Building up capital and printing covered for funding? 

Mastenbroek, Commerzbank: As an issuer you’re not only driven by what investors want to buy. You obviously need capital but try to limit the issuance at a reasonably level because it’s expensive. And you use covered bonds to optimise your funding costs.

EUROWEEK: Do you think that kind of shape of supply could characterise this part of the year going forward? It’s something I’ve seen mentioned by syndicators in the past couple of weeks, because of the supply we’ve seen since the markets re-opened, the barbell theme.

Iserief, ING: There will be a lot more capital issuance going forward and there will be a lot of banks focusing on repairing their net interest margin. And then of course the covered bond market is a very nice tool to reduce your cost of funds. On the other hand, as everybody has said, you have to balance that with asset encumbrance. You want to maintain some spare room in your cover pool as a sort of silver bullet for stressed out times. 

Green, Lloyds: That’s a very good point. Covered bonds are a safety net, if you like. It’s the market that generally stays open the longest. But I suppose in terms of current supply, yes, there’s been a lot of covered bond supply. But I think there’s been a fair distribution of covered and senior in 2013, so there’s been a reasonable balance. 

I suppose one of the factors that we have right now is that covered bonds are coming from peripheral issuers who maybe don’t have access to the senior funding market. So what we may see for the rest of the year is banks wanting to be opportunistic and pre-funding at a low cost, and covered bonds offer that.

Iserief, ING: It’s also a bit peculiar that on the one hand we’re issuing covered bonds and on the other side, for the liquidity coverage ratio (LCR) portfolio we’re buying these as level two assets. And all of a sudden the world’s become safer? It has eluded me how that works. So if you talk about the cost of issuance as a lot of these research pieces do, on the flipside that means you have some very low yielding assets in the LCR portfolio. That’s not always a good trade. 

EUROWEEK: I was going to ask about that. How important are the LCR and the net stable funding ratio (NSFR) for you right now?

Iserief, ING: On the NSFR, not so much right now. I think that asset origination directives have gone out to make sure it’s clear that really long dated assets are not necessarily what we’re looking for right now. I understand that fairly long dated project finance deals are more and more taking on the refinancing risks that used to be kept at the bank. So for now it seems more a consideration on the asset side. But it’s still a very vague ratio that is open to debate. 

Mastenbroek, Commerzbank: Yes, and the other thing that helps universal banks is that when calculating the NSFR as it stands right now the deposits from the client franchise go into the equation with a pretty high level of stability. To me, it seems that the market is less concerned about NSFR. When it was first introduced there was lots of analysis calculating the gaps that all the banks had and everybody said the market was never going to provide enough funding to fill the gap. But the focus is now on other things.

EUROWEEK: I know we’ve talked briefly about bail-in and it is related, but let’s talk about banking union. I was reading a research paper this morning from Fitch which argued that one negative result of banking union could be that as we move towards a system of pan-European regulation, banks could open operations across Europe so they would be competing for funds in foreign markets and lending in others, and that could mean that banks that operate in deposit heavy jurisdictions could end up having to pay more for funding. Is that a concern for you at all? Do you see any negative cost implications of banking union or would it equalise things a bit more?

Iserief, ING: As a truly European bank, I think it would be a really good thing to have the European regulation, but I think there is a lot of water to be passed under the bridge before we see the Germans allowing their deposit guarantee scheme to finance French mortgages, let’s put it that way. 

El-Amir, UniCredit: Yes, I think Draghi didn’t want to mention UniCredit by name but I think he was on record two or three months ago saying, ‘I just found out that there’s a bank based in Milan which funds at 150bp wider than the Munich entity’.

It’s pretty clear which bank he was talking about. Theoretically the whole European project is about free flow of capital and labour but I think the UK and Germany have probably been the most protective on bail-in. The UK wants to have absolute discretion on everything and it just doesn’t work. We’re always trying to harmonise everything. And in Germany there is both trapped liquidity and trapped capital, so there’s not a free flow of capital.

My own interpretation is that the ECB taking over is going to lead to another layer of regulatory complexity that we’re going to have to deal with. It’s not like the ECB is going to have so much power that you can say you have one European regulator and all your problems are solved. It’s actually going to make our job more difficult, at least initially. 

EUROWEEK: Let’s move on to securitization. As a financing product, do you think it’s still suffering from its reputation and the fallout from the crisis, and do you think it could be a more useful funding tool going forward?

Green, Lloyds: From a UK perspective it’s been widely used as one of the tools in the toolkit for the last two, three, or four years. We’ve seen a wide variety of trades from UK institutions across asset classes, such as RMBS, autos and credit card deals. It has been a useful funding tool and we’ve seen a contraction in funding spreads, just as we’ve seen in covered bonds and senior. It’s not suffering from a poor perception in the UK. The breadth of the investor base is not as wide as for other asset classes but it has been a useful tool and it continues to be something that we focus on. As part of that diversified funding mix it does and will continue to play a role. 

Iserief, ING: It is a bit of a niche market. Commerzbank has been very heavily involved in some of these more structured covered bond products though. I’m wondering, given the size in which you do it, does it really have an impact on the balance sheet?

Mastenbroek, Commerzbank: Well, for us securitization is not a funding tool but as a means for capital optimisation. However, when doing the SME structured covered bond project I came across a lot of ABS investors and my impression was that the market would like to buy much more ABS than it is being provided with. When we presented the structured covered bonds we often heard people say they liked the concept but they rather wanted SME exposure in ABS format. And the reason was obvious, because had we issued an ABS we would have had to pay more than our senior unsecured funding spread, while the spread of the structured covered bond is significantly below it.

Iserief, ING: It’s a club on its own, the ABS buyers. 

El-Amir,UniCredit: Also, the largest asset class in ABS, which is RMBS, is still, at least for our entities, significantly more expensive than covered bonds, even when you adjust for all the credit enhancements. It’s still a lot cheaper to issue covered. Until that changes I don’t see a lot of people wanting to issue RMBS if they have the ability to do covered. 

EUROWEEK: In in your opening gambits today, private placements seemed to be a bit of a theme. Has the importance of the private market changed over the past few years? Has it been there as a backstop or is it a fairly solid base of demand?

Green, Lloyds: We see a solid base of demand and from a pricing perspective it has advantages over public benchmarks. I keep coming back to diversification, and I guess in certain products, it’s a very specific investor base. Plain vanilla instruments have more cross-over with the benchmark space. It’s a product and a market that you can’t really turn on and off, because some of the investors rely on certainty of execution. If you’re out of the market you don’t necessarily drop off the buyer list but you become less of a priority than if you are there and consistent in the way that you approach the market. 

Our MTN team is very flexible in its approach to the market across the lifecycle of the deal, from issuance to buybacks. We’re also flexible in terms of the structures and currencies that we’re able to issue. We’ve made headway in institutional and retail markets across the globe, as part of the effort to be able to access as many pockets of liquidity as we need. Certainly it has been a consistent source of funding for us and I think Bas and other Dutch issuers have been pretty active in private placements. There is good volume to be had, at cheaper funding levels. So it does make an awful lot of sense for that to be a consistent basis for your funding mix. 

Iserief, ING: It’s useful in terms of levels. If you go into the market with a benchmark size deal then you pay a certain new issue premium which will definitely be based on your secondary curve. But if you get investors calling you up and saying we would like to place some money with you, where would you take our money, you get to do these private placements at decent levels and really find out where supply and demand meets. 

I find that generally speaking, private placement levels and benchmark levels are sometimes even something like 40bp apart. It can be very cheap funding, especially if you compare it to going out into the market for a benchmark deal. It is less in your own hands, of course. Sometimes it’s there and sometimes it’s not. 

Mastenbroek, Commerzbank: That’s true. As I said at the beginning, given the very low senior unsecured requirements that we have at the moment, we are able to cover 100% of our needs via private placements. There’s a certain amount which you can do every year and there’s a constant flow of transactions, especially when you have an investment bank which has many institutional clients, plus you can place into your retail network. But it can only make up a certain layer in your funding structure. It has limits.

In Germany the market has traditionally been strong and big, with insurance companies and corporate pension funds predominantly buying private placements. This market is still very important for covered bonds, but has shrunk for senior unsecured paper because of, again, new regulation, in this case Solvency II. Unsecured private placements are more concentrated on structured business nowadays. In many cases we achieve very cheap funding levels because investors are interested in a combined product that offers them some kind of embedded derivative.

Hombert, Natixis: I agree with Rainer that there is a lot of demand on the German side and we are doing a lot of trades there. But also, we see that some investors are doing huge block trades now and they are coming in for very large amounts as they are not finding what they need on the public side. They’re very large tickets and the idea is that the issuer does the private placement, then they will tap it and make it liquid. That’s another trend we are seeing in addition to the huge German investor base in private placements.

EUROWEEK: What about other private markets that aren’t quite so visible?  I’m thinking of things like term repo, for example. How much do you guys interact with those markets, is it a big source of funding?

Iserief, ING: It was — it used to be interesting before Draghi decided to save the world. At that time some banks were fairly starved of funding and were ready to encumber all sorts of assets for a long time at amazingly expensive levels. But by the time that the investors got on board, Draghi saved the world and it dried up. All these salespeople had all these investors lined up, and we had to tell them sorry, actually we’re going to do it the other way round now. It was a good way to use LTRO money, although we didn’t partake in the LTRO. 

EUROWEEK: Just how much of an issue is paying back the LTRO, and banks weaning themselves off that central bank funding, going to be in the next few years? We’ve all heard it said many times that lots of southern Europe would be bankrupt without the LTRO.

El-Amir, UniCredit: Well, I’ll challenge that statement. I think it’s less about geography and it’s more about access to different funding markets and the size of the institution. Larger banks in southern Europe never really had an issue. The Spanish were earlier than the Italian banking system paying back the LTRO, partly because we’ve had different views on funding — we wanted to have a much more conservative funding profile and a very, very liquid balance sheet. So within our own institution there was a lot of agonising about whether to start to pay back the LTRO. 

But I think the large banks never really had an issue. For the smaller institutions I think they may still have potential issues around funding. They’re having to go back to ABS — some of the smaller Italian banks are having to rely on asset backed financing because, as Peter said, they don’t have access to the senior wholesale markets or it’s pretty challenging or expensive to get access. 

Mastenbroek, Commerzbank: There is already some talk in the market about an early roll of the LTRO. That would imply that we’re not yet at the point where long term ECB liquidity can be taken away.

Iserief, ING: But it won’t be the massive size that we saw before. How many banks just thought it was cheap funding and got in there in size, only to find out they couldn’t deploy the money and had to deposit it at the central bank with negative carry? As we concluded, a lot of banks don’t really need all that much long term funding. Shorter term funding and funds entrusted have increased quite a bit. Adding it all up I wouldn’t be surprised if it was nowhere near the size we saw before. 

Mastenbroek, Commerzbank: The thing is that in between now and then we’ve had these various statements from the ECB about doing whatever it takes to save the euro. Before those statements, many banks probably participated in the LTRO just to be on the safe side, but I think many will now be of the opinion that it’s not necessary anymore. So the ones who don’t need it for their long term funding ratios are not likely to participate in the roll. 

EUROWEEK: Let’s wrap up with one parting question. What is the biggest challenge facing the bank funding markets over the next 12 months?

Green, Lloyds: I think the catch-all would be the macroeconomic challenge. There are one or two events that could blow up, that’s a fact of life. But what we’ve seen over the past two or three years is that credit markets have got better at dealing with event risk and the periods that markets close down for have become shorter. 

Iserief, ING: If anything, I’m still worried about the extremely small warehousing capability of trading banks and market makers. Like I said earlier, your secondary trading levels can be all over the place just because of low volumes. That’s the only thing I worry about right now. And of course going through the big, long haul of new regulation. I think we’re getting used to that. 

Hombert, Natixis: I think the challenges are more on the asset side. How to earn money in a low interest environment and how to deal with all the regulation. Complying with all the regulations, keeping up, fulfilling the requirements, having enough capital and so on and still making enough profit — that’s the challenge on the funding side.

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