REFILE-Funding for Lending to cripple UK supply
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* UK bank bond volumes to shrink across the board
* Lack of supply to drive spreads tighter
* Foreign issuers to take advantage of funding gap
By Aimee Donnellan
LONDON, Sept 21 (IFR) - The Bank of England's Funding for Lending Scheme (FLS) has sent a wave of panic through the UK investor community as accounts brace themselves for a sharp drop-off in bond issuance leaving them scrambling to find other investment avenues.
The Bank of England's attempt to lift the economy out of recession, making cheap funding available to banks up to 5% of their existing loans (some GBP80bn), could not have come at a worse time for the bond market.
The availability of bank bonds in the form of senior, covered and ABS paper has been in decline in recent years as the country's banks reign in their bulging balance sheets, and this year they've also been conducting liability management programmes.
The last year saw the most active period on record for European bank liability management, with over EUR200bn of debt targeted through exchanges, according to Barclays research.
"Investors can't ignore the fact that we are running out of new issuance opportunities in the banking space," said Ian Robinson, head of credit at F&C.
"We are all bracing ourselves for a market with fewer financial bonds which poses a problem in the short term but a rebalancing from financials to non-financials is necessary."
According to Thomson Reuters data, UK banks have so far issued USD92bn senior, USD32bn of asset-backed and USD10bn of covered bonds this year, a run rate pretty much in line with what was achieved in 2011, but dramatically lower than supply seen at the height of credit bubble. In 2007, issuance in ABS soared to USD325bn, senior reached USD152bn and covered hit USD34bn.
The expected contraction of the credit market is driving investors to scramble for bonds in the secondary market, leading to an average 100bp tightening across all three markets.
"Overall funding is likely to be reduced next year," said David Hague, UK FIG DCM at RBS. "On the buy-side there will be fewer covered, senior and RMBS bonds and the frequency to which issuers come to the market will also be reduced."
Investors share that viewpoint and say they are expecting investment opportunities to dry up in the coming months.
"It's not just that we are seeing a decline in funding requirements, but with banks like Lloyds and RBS actively buying back senior bonds we are seeing an even quicker reduction in bonds outstanding," said Robinson.
This anxiety about future issuance was evident in the market over the past two weeks when RBS, Barclays and Lloyds launched liability management exercises to make further use of their considerable liquidity excess.
So far, the results of the Barclays and RBS tender offers have shown that investors are keen to keep hold of their bonds.
Barclays only managed to buy-back 30% of its senior notes while RBS only achieved 25% of its target.
"The liability management exercises are highlighting that a number of investors are aware of how central bank schemes (including the FLS) will impact the prospects for future bank issuance and are therefore unwilling to part with their bonds," said Hague.
Bank treasurers have taken note of this investor anxiety and in some cases are continuing with funding programmes in order to maintain investor relations.
In the ABS space, Yorkshire Building Society is selling a public RMBS, conceding the deal is a nod to investor relations, rather than a reflection of the tighter pricing available since the summer rally in UK prime mortgage-backed bonds.
"It isn't really about price - based on what we're likely to get, Funding for Lending is definitely cheaper, and we could easily place the whole deal with the Bank," said Chris Parrish, group treasurer of Yorkshire Building Society.
"But that's not really helpful from an investor point of view, and we want to keep our funding channels open."
The Co-op is also gearing up for an investor roadshow beginning next week, likely to be followed by a deal.
"Deals are likely to be smaller and more sporadic over the course of next year. Issuance will be driven by a need to demonstrate commitment to a funding programme rather than an actual need to access the public market," said Hugo Moore, head of frequent borrowers at HSBC.
JP Morgan analysts said in a research note: "We expect the most frequent issuers to maintain their current, relatively predictable issuance schedule, but to reduce the likely size of H2 2012/2013 new issues."
Florian Eichert, covered bond analyst at Credit Agricole CIB believes it's possible that we won't see any new UK issuance in euro format until year end.
FILLING THE GAP
The scheme saw its first participant on Wednesday when Lloyds drew GBP1bn from the Bank of England.
And although other UK banks look set to focus their funding efforts on the FLS for the rest of the year and into 2013, bankers appear confident that the market will adapt.
Foreign issuers from Australia, the Nordics and even some Northern European borrowers are expected to tap into the excess demand that will not be met by UK banks.
"Australian banks are well known throughout Europe for being strong credits that can achieve size in the market. We're also likely to see an increase in US banks coming to the market as Wells Fargo and JP Morgan have already shown there is plenty of demand for US credit in this traditionally undersupplied market," said Hague. (Reporting by Aimee Donnellan; Editing by Helene, Alex Chambers and Julian Baker)
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