Investors prepare for bond pricing push-back

Fri May 30, 2014 9:51am EDT

* Banks face higher new issue premiums

* ECB inaction could cause calamitous correction

* Investors continue to find value in peripheral and subordinated bonds

By Aimee Donnellan

LONDON, May 30 (IFR) - The strongest European banks are struggling to capitalise on the performance of their bonds in the secondary market as expectations of ECB action to boost the economy drive yields down to what investors view as irrationally low levels.

Credit Suisse provided the clearest example of this challenge earlier this week when it had to pay some 20bp - double the sector's typical new issue premium - to ensure the success of a sizeable 1.75bn five-year bond.

"Most deals that have come are oversubscribed and getting done but with the strong supply pipeline it's more difficult to push the limits on new trades," said Christoph Hittmair, head of European FIG DCM at HSBC.

"Also, on the back of the recent supply, we have seen something of a levelling off of spreads and demand for higher new issue premiums from investors."

Over the past month, global financials have flooded the European market with around 40bn-equivalent of euro and sterling debt, compared to just 10bn sold during May 2013.

Part of investors' problem is a lack of performance from deals. A 750m 12-year bond from Goldman Sachs initially widened after pricing despite a solid book. Meanwhile Credit Suisse failed to offer investors any upside, with its senior unsecured transaction wrapped around reoffer.

"From our perspective senior unsecured bonds are just too tight these days, particularly from core credits," said Robert Montague, a senior investment analyst at ECM Asset Management.

"Banks are still printing deals at levels that are attractive for the issuer but we have certain spread targets and some of these recent offerings aren't meeting those."

The cost of insuring unsecured debt as measured by the iTraxx Senior Financial index is continuing to decline. In the past month, it fell a further 5bp to 72bp, while 10-year bond spreads for stronger banks and peripheral issuers tightened around 15bp and 20bp, respectively.

Against this bullish backdrop, borrowers are being encouraged to offer reasonable premiums for their own good and that of investors.

"We are seeing good demand for those issuers that have started with sensible IPTs and not tried to extract the last basis point from the market with the final pricing, and they also do better in the after-market," said Alexandra MacMahon, head of FIG debt capital markets for Europe, Middle East and Africa at Citigroup.

"Other deals haven't fared as well in the secondary given softer tone and the rally in rates, particularly those offering less scarcity value."

CORE ON BACK FOOT

The ECB-inspired rally has helped create something of an anomaly, as strong credits from the core pay higher new issue premiums than riskier subordinated paper and peripheral deals.

In the covered bond space, spreads have also tightened aggressively in recent weeks after rumours that Europe's top banking regulator will award them the highest liquidity status. That would potentially give a huge boost to the asset class by creating a captive investor base.

Against this backdrop, higher yielding senior peripheral and subordinated bonds are the last sectors where investors are still willing to enthusiastically buy into deals.

"In the subordinated bond market we are still seeing a lot of demand despite the fact that we feel there is limited value," said Montague. (Reporting by Aimee Donnellan; Additional reporting Helene Durand; Editing by Alex Chambers and Julian Baker)