Market comment:
The debt crisis continues and Italy remains the biggest worry as sovereign yields continue to stay at very elevated levels despite the ECB buying sovereign debt during the week. The Italian crisis was followed by a poor auction of Spanish government bonds on Thursday. This suggests that it will take a very significant effort (most likely by the ECB) to bring back some market confidence. The most likely scenario is that Europe will continue muddling through the crisis. The alternative is simply bad.
Poor conditions for sovereign debt translate directly into poor performance of financial credits. The senior financial CDS index has widened to above 300bp again, thereby approaching the previous high that was recorded in September. The weak conditions for financials were also illustrated by a very weak Q3 report from UniCredit, which was followed by the announcement of a significant rights issue. The poor sentiment towards banks has lately once again translated into the interbank market where we see rising spreads between 3M Euribor and EONIA spreads. This may pave the way for additional central bank liquidity measures relatively soon.
The Nordic banks are characterised by being low beta compared with their European
peers. The robust fundamentals of the Nordic sovereigns function as a backing of the Nordic banks and, relatively speaking, their position is thereby strengthened. To illustrate the relative strength of the Nordic countries, the Kingdom of Sweden printed a 30-year bond yielding 2.16% on Wednesday.
For corporate credit, the picture remains more positive. RCI Banque (the financing arm of Renault) came to the market with a 2Y bond and the Société des Autoroutes Paris-Rhin-Rhône issued a 5Y bond of EUR0.5bn. In addition, Vinci will be roadshowing next week and thus a transaction in that name may be imminent.
Buybacks of subordinated debt gather pace - the Genie is out of the bottle
The sentiment towards subordinated bank debt is deteriorating on the back of the poor economic environment for banks. This has now prompted a number of banks (Santander, SNS, BNP, Soc. Gen., Jyske Bank) to launch tender and exchange offers for their outstanding subordinated debt. In the coming weeks more are likely as we see it.
For banks, the incentive is that the depressed market prices offer an opportunity for banks to “create” Core Tier 1 capital as they buy back bonds at prices much below par that are booked in the accounts at par. This creates a profit through the P&L and thereby an increase in the Core Tier 1 capital. On the other hand, it lowers the total capital. EBA, the Basel committee and rating agencies have a clear preference for Core Tier 1 capital and therefore such a move makes sense from a capital management perspective.
The flipside of these manoeuvres is that it requires funding and funding has become a rare and expensive commodity for banks. Therefore, the prices banks pay for their outstanding sub debt are more often than not significantly lower than the price at which senior unsecured funding is available today. Hence, the implicit costs of making a tender may actually be substantial through a lower net interest income going forward.
To address this issue, e.g. Santander has actually made an exchange offer rather than a cash buyback offer. The exchange will be made into senior unsecured bonds at a discounted spread such that the new senior bond will be priced more or less at the existing curve for the subordinated bonds. This largely addresses the funding issue that a tender offer would result in, but may not be particularly attractive for existing holders of the sub debt who will have to crystallise their mark to market losses.
Furthermore, the banks that have tendered/exchanged have made it clear that future decisions to call outstanding sub debt will be made on economic grounds. Hence, the probability of these banks not calling is high as the replacement funding costs are far higher. As we see it, this means that the genie is out of the bottle for banks and that potentially a large number of them will decide on not calling their sub debt – this is especially the case in the periphery countries where funding levels are particularly elevated (if possible to get funding at all).
In the Nordic region, we think the situation is a little different and we consider extension risk to be lower compared to elsewhere in Europe. First of all, the Core Tier 1 capital ratios of the large Nordic banks are high and therefore the need to create Core Tier 1 capital is lower. Furthermore, the cash prices of the subordinated instruments are far from as depressed as elsewhere in Europe and the capital gain of tendering is therefore lower. Secondly, the Nordic banks have gained a position as a safe haven among European banks thereby benefitting from lower funding levels and a better reputation. This implies that the banks have access to replacement funding at reasonable levels and therefore exchanges would make less economic sense. With funding and capital being less of an issue for Nordic banks we therefore think that the upside is limited and not adequate to offset any damage to reputation a non-call would potentially cause.
Having said all this, we need to stress that extension risk has increased also for Nordic banks as the stigma of not calling is becoming lower. Still, our base case is that the large Nordic banks will call their subordinated debt at first call.
Concerning the Jyske Bank tender that was announced today, we view it as a special case as it relates to Tier 1 CMS bonds that were not priced to first call but as a perpetual. Hence the capital gain is big (tender price of 55 implies a core tier 1 gain of 45%* EUR 50m) and the reputational risk low as these particular instruments are already seen by the market as true perps rather than callable bonds. This is underlined by Jyske who states in relation to the tender that "any future decisions as to whether Jyske will exercise calls in respect of capital securities not tendered pursuant to the Offer will be taken with regard to the economic impact of exercising such calls in the then prevailing market conditions”.
The debt crisis continues and Italy remains the biggest worry as sovereign yields continue to stay at very elevated levels despite the ECB buying sovereign debt during the week. The Italian crisis was followed by a poor auction of Spanish government bonds on Thursday. This suggests that it will take a very significant effort (most likely by the ECB) to bring back some market confidence. The most likely scenario is that Europe will continue muddling through the crisis. The alternative is simply bad.
Poor conditions for sovereign debt translate directly into poor performance of financial credits. The senior financial CDS index has widened to above 300bp again, thereby approaching the previous high that was recorded in September. The weak conditions for financials were also illustrated by a very weak Q3 report from UniCredit, which was followed by the announcement of a significant rights issue. The poor sentiment towards banks has lately once again translated into the interbank market where we see rising spreads between 3M Euribor and EONIA spreads. This may pave the way for additional central bank liquidity measures relatively soon.
The Nordic banks are characterised by being low beta compared with their European
peers. The robust fundamentals of the Nordic sovereigns function as a backing of the Nordic banks and, relatively speaking, their position is thereby strengthened. To illustrate the relative strength of the Nordic countries, the Kingdom of Sweden printed a 30-year bond yielding 2.16% on Wednesday.
For corporate credit, the picture remains more positive. RCI Banque (the financing arm of Renault) came to the market with a 2Y bond and the Société des Autoroutes Paris-Rhin-Rhône issued a 5Y bond of EUR0.5bn. In addition, Vinci will be roadshowing next week and thus a transaction in that name may be imminent.
Buybacks of subordinated debt gather pace - the Genie is out of the bottle
The sentiment towards subordinated bank debt is deteriorating on the back of the poor economic environment for banks. This has now prompted a number of banks (Santander, SNS, BNP, Soc. Gen., Jyske Bank) to launch tender and exchange offers for their outstanding subordinated debt. In the coming weeks more are likely as we see it.
For banks, the incentive is that the depressed market prices offer an opportunity for banks to “create” Core Tier 1 capital as they buy back bonds at prices much below par that are booked in the accounts at par. This creates a profit through the P&L and thereby an increase in the Core Tier 1 capital. On the other hand, it lowers the total capital. EBA, the Basel committee and rating agencies have a clear preference for Core Tier 1 capital and therefore such a move makes sense from a capital management perspective.
The flipside of these manoeuvres is that it requires funding and funding has become a rare and expensive commodity for banks. Therefore, the prices banks pay for their outstanding sub debt are more often than not significantly lower than the price at which senior unsecured funding is available today. Hence, the implicit costs of making a tender may actually be substantial through a lower net interest income going forward.
To address this issue, e.g. Santander has actually made an exchange offer rather than a cash buyback offer. The exchange will be made into senior unsecured bonds at a discounted spread such that the new senior bond will be priced more or less at the existing curve for the subordinated bonds. This largely addresses the funding issue that a tender offer would result in, but may not be particularly attractive for existing holders of the sub debt who will have to crystallise their mark to market losses.
Furthermore, the banks that have tendered/exchanged have made it clear that future decisions to call outstanding sub debt will be made on economic grounds. Hence, the probability of these banks not calling is high as the replacement funding costs are far higher. As we see it, this means that the genie is out of the bottle for banks and that potentially a large number of them will decide on not calling their sub debt – this is especially the case in the periphery countries where funding levels are particularly elevated (if possible to get funding at all).
In the Nordic region, we think the situation is a little different and we consider extension risk to be lower compared to elsewhere in Europe. First of all, the Core Tier 1 capital ratios of the large Nordic banks are high and therefore the need to create Core Tier 1 capital is lower. Furthermore, the cash prices of the subordinated instruments are far from as depressed as elsewhere in Europe and the capital gain of tendering is therefore lower. Secondly, the Nordic banks have gained a position as a safe haven among European banks thereby benefitting from lower funding levels and a better reputation. This implies that the banks have access to replacement funding at reasonable levels and therefore exchanges would make less economic sense. With funding and capital being less of an issue for Nordic banks we therefore think that the upside is limited and not adequate to offset any damage to reputation a non-call would potentially cause.
Having said all this, we need to stress that extension risk has increased also for Nordic banks as the stigma of not calling is becoming lower. Still, our base case is that the large Nordic banks will call their subordinated debt at first call.
Concerning the Jyske Bank tender that was announced today, we view it as a special case as it relates to Tier 1 CMS bonds that were not priced to first call but as a perpetual. Hence the capital gain is big (tender price of 55 implies a core tier 1 gain of 45%* EUR 50m) and the reputational risk low as these particular instruments are already seen by the market as true perps rather than callable bonds. This is underlined by Jyske who states in relation to the tender that "any future decisions as to whether Jyske will exercise calls in respect of capital securities not tendered pursuant to the Offer will be taken with regard to the economic impact of exercising such calls in the then prevailing market conditions”.