MTNs adapt as deleveraging serves up new challenges
Privately placed Euro-medium term notes have given banks some excellent opportunities to print through their curve this year. But attractive pricing is not the only advantage that the evolving market has to offer, as new investors and issuers are finding. Craig McGlashan reports.
If any issuer sums up the tantalising pricing that MTNs have been able to offer over syndicated deals this year it is Swedbank.
With the public markets all but shut in August, the bank was able to raise €120m by tapping its September 2016 floating rate notes three times in one day despite having tightened its offered levels in the weeks leading into the trade and tightening again after each of the taps.
But MTNs offer more than tight pricing, says Kimmy Samuelsson, head of long term funding at Swedbank in Stockholm. “When the US Federal Reserve started talking about tapering, spreads widened out and investors had to reassess what would happen with rates and what kind of new issue premium to expect,” he says. “But in private placements nothing happened — the demand kept coming. It allows us to keep our ear to the ground at all times. It also gives flexibility. When we are roadshowing we don’t have to shut down — investors can do MTNs with us. It also helps us have a good relationship with investors generally.”
Around one third of Swedbank’s total funding has been through MTNs year to date, up from one quarter last year. The increased demand has in part come from traditional benchmark investors, says Samuelsson. Starved of supply in the public markets as banks deleverage, these investors have considered private placements, leading to reverse enquires of €100m-€200m across the curve — much larger than Swedbank is used to receiving.
Swedbank’s MTNs are typically sold to one investor — the classic MTN set-up — with deals often triggering further interest once they hit screens, as with its September 2016 FRN tap. But for other issuers, club deals involving a handful of buyers are growing in popularity because of the changing investor base. The new investors often have different requirements to traditional clients, meaning a pure private placement will not do.
“A large portion of deals at the short end of the curve are in club format,” says Andrew Nicola, head of MTNs at Commerzbank in London. “That’s driven by dealers pushing their important issuer clients and investors where volume and liquidity is a key point for investor participation. Additionally, many investors have a requirement to only hold a certain percentage of a transaction and are comforted by other investors participating. The challenge is bringing those investors together at the same time for the same pricing.”
If that challenge can be met, there are rewards for both issuers and investors. “Larger tickets reduce issuers’ workload, although smaller tickets should generally mean a lower cost of funding,” says Nicola.
Elsa Martin, head of the MTN desk at Natixis in Paris, adds: “They’re quicker than benchmarks and issuers can be sure they’ll satisfy all investors which is not always the case with a benchmark — investors can be quite disappointed with allocation.”
But club deals bring more challenges than just matching investors. Unused to the MTN market, these new clients expect a premium for the low liquidity private and club deals provide compared to benchmark deals, but face issuers expecting to price through secondaries.
“Some of the investors in the market now do not expect much of a price difference between a club deal and a benchmark,” says Martin.
Dealers have to manage the expectations of both sides of the transaction, but there are signs that the balance is tipping in issuers’ favour.
“With supply dropping and demand increasing issuers will generally insist that sub-benchmark deals still need to come through their curve, though not all issuers subscribe to that view,” says Commerzbank’s Nicola.
Short of structures
While club-type deals help boost volumes, a former mainstay of the market remains limited in size. Structured deals — immensely popular until the global financial crisis led to a rapid decline in appetite for exotic deals — cannot benefit from the growing club deal market because they are too complex to involve more than one investor.
Dealers differ on the state of the structured market. Natixis’s Martin says there has been even less demand for the products overall this year than last while Commerzbank’s Nicola reports a slight increase. But both agree that some specific products have done well.
“Callable notes remain popular,” says Martin. “In Europe, only really light structures have seen an uptick — single call fixed rate and zero coupon. In Asia and the US, long maturity multi-callable fixed rate and zero coupons are growing, with more steepeners in the US. Commodity and credit-linked notes have grown in importance, with private banks the main buyers.”
Nicola agrees that callable deals have been popular this year, along with zero to fixed rate notes, CMS switchers and range accruals.
While diminished from its heyday, the structured market still offers some great opportunities for those issuers willing to participate, says Nicola. “The banks that can do structures have benefitted this year,” he says. “They save over vanilla pricing.”
One such issuer is Lloyds Bank. Since first printing MTNs in the mid-1990s, MTNs have made up between 20% and 100% of its overall senior unsecured funding each year, depending on its needs and the wider economic environment. Aside from pricing inside its curve, Lloyds enjoys the diversification that MTNs offer.
“Lloyds’ structured notes and vanilla private placements are purchased by institutions as well as private banking and to some extent retail,” says Suzy Margretts, senior director, MTNs at Lloyds in London.
“We issue off multiple platforms via a panel of arrangers to investors in Europe, Asia and US. These include EMTNs, notes, certificates, US shelf, 144A, Uridashi and Schuldscheine. A buyer of structured notes purchases Lloyds’ credit as well the view on a particular asset class via the embedded derivative. To accommodate this investor base we show flexibility on size, structure, currency and lifecycle. We quote both on issuance and buybacks.”
Structured issuers faced a new challenge in 2013. In the past, issuers could create supplementary documentation when printing a structure not included in the original prospectus — but not anymore. An amendment to the EU Prospectus Directive required issuers to include the details of products they may issue over the next year in their MTN programmes by June 30.
That led some issuers to shun structures altogether, with the legal costs in documenting potential structures not worth the price savings they might make.
To stay in the structured game, regular issuers had to adopt new tactics. “Lloyds’ approach was to survey the major arranger houses for the most commonly used products and embed these into one single programme,” says Margretts.
“This approach does mean we do not currently issue to retail investors in Europe but, depending on demand, we may review in 2014. We do, however, have the ability to issue to retail in Japan and US as this is issued off different platforms, and, as in previous years, much of our demand comes from institutional and wealth management investors across Europe, Asia and the US.”
New regulations that compel banks to deleverage have hit bank MTN volume in a similar fashion to the public market. That has forced dealers to look to new markets to fill up supply channels. But other forces unique to MTNs have also promoted a drive into new jurisdictions.
“In days gone by, bank investors used to come to their preferred dealer for structured pricing and execution, but now those investors who are doing size — maybe €50m or €100m — want to involve as many dealers as possible,” says Commerzbank’s Nicola.
“That means fierce competition, margins cut to the bone and there are opportunities to take advantage of dealer desire to print and of course occasional mispricing. Investors are becoming savvier across Europe about our business, forcing us to find new credits and investors. That’s one of the dynamics of the market we exist in today and this actually helps us because it forces us to become innovative and spread the net far and wide to serve our issuers and investors.”
Asian banks have joined, along with Turkish credits and others from the Middle East. Banks from central and eastern Europe, including Russia, and Latin America are also involved.
“We’re doing more and more work with our origination teams to get these issuers on board,” says Nicola. “Many Latin American issuers have never really been aware there is an international private placement market available to them. Investors are looking for diversification so, if lines can be opened, they have an appetite for new and interesting names.”
Despite these new issuers, Natixis’s Martin doubts the market will get back to pre-crisis volumes, particularly as banks have smaller funding needs — even though that sometimes makes private deals more attractive.
“Some issuers had done 75% of their funding needs in the first quarter of the year,” she says. “Therefore they were looking only at private placements. But at the same time investors are requesting liquidity and European Central Bank repo eligibility, which reduces the volume of the private placement market.”
Commerzbank’s Nicola does see room for growth, however, particularly if the structured market grows as investors attempt to take advantage of the steepening forward curve. But new issuers will be the main driver behind increased volumes, he says.
One threat to growth would be an increase in rates — something that appears at least on the horizon, albeit distantly, after the Fed said in May that it would consider tapering its quantitative easing programme this year.
All markets, MTNs included, need to adapt accordingly, says Nicola. But he also sees opportunities for the MTN industry when tapering eventually begins. “Tapering will cause markets to perform in line with their economic fundamentals,” he says. “With interest rates continuing to rise, bank funding will become more expensive and we’ll see a more individualistic approach from central banks to deal with the fallout. That will lead issuers to have a greater dependency on cheaper MTN funding versus more expensive benchmarks, which will support the trend for club-type deals.”