(This story originally appeared in IFR, a Thomson Reuters publication)
By Danielle Robinson and Helene Durand
LONDON, Aug 19 (IFR) - European banks are expected to flock to the Yankee bond market with Additional Tier 1 and Tier 2 issuance in the autumn, lured by attractive funding costs.
A sharp rally in dollar-denominated European Tier 2 securities last week made it possible for certain European banks to reap at least 50bp of savings if they go to the US market rather than euros, including the cost of swapping back to their home currency.
Bankers differ on how much savings are to be had by issuing AT1s in dollars. But most agree that the Yankee market will be the place for Europe’s financials if they want a combination of large deal size, strong demand and better pricing for capital.
“The dollar market is more competitive right now and the basis swap has moved in favour of European borrowers issuing in dollars and swapping back to euros, so we could see financials look to take advantage of this,” said Alexandra MacMahon, head of FIG DCM for EMEA at Citigroup.
The biggest savings, according to US FIG bankers, is in the Yankee Tier 2 space, where names such as Commerzbank and Intesa Sanpaolo saw spreads contract by as much as 8bp a day.
“Yankee Tier 2 spreads have been ripping tighter, especially in the last few days,” said a senior FIG banker at one of the biggest US bank bond houses in New York.
“While senior and sub US bank debt isn’t moving much tighter, some Yankee bank sub debt has tightened 4bp-8bp on a daily basis and some names are about 20bp tighter over the past few trading days,” he added.
Commerzbank’s 8.125% September 2023 subordinated bonds were trading at 305bp last Thursday, 35bp tighter than their 340bp level the previous Friday and compared with tights of 255bp in June.
While Tier 2 spreads might be off their tights, the all-in yield has benefited from a strong rate rally since then, with 10-year Treasury yields at 2.30% on Friday, down from around 2.60% at the end of June.
Even callable securities appear to be doing well in the US market, according to the FIG banker in New York.
“Yankee Tier 2 spreads have been ripping tighter, especially in the last few days. There’s not a huge depth of demand for callables in our market but, even so, we are seeing 10NC5 levels [on Yankee European bank capital] that are at least a good 40bp through on a swapped-back-to-euro basis, so [the saving in the US dollar market] is meaningful in Tier 2.”
European banks issuing Tier 2 are likely to be swamped with demand from US investors because the instruments will appeal to the traditional fixed income investor that does not take on the AT1 or US preferred product.
Additional Tier 1 bonds also rebounded last week in both the euro and US markets, although opinions on how much savings in spread terms were available in dollars were mixed.
Some European FIG bankers thought the Additional Tier 1 savings were as much as 75bp for certain European banks to issue in dollars and swap back to euros, while the US FIG banker thought dollar new issue spreads on a swapped basis were probably only marginally better.
Even so, the Yankee market’s trump card is the tiny amount of AT1 paper available, compared with the euro market.
“In the European market there is ample opportunity to buy euro-denominated bank paper, whereas the opportunity to buy AT1s in the [144A or SEC-registered] dollar market is much more limited,” said a head of FIG syndicate at an investment bank in New York.
The European investor base is also still smarting from Banco Espirito Santo’s collapse and the decision to abandon its Tier 2 bondholders.
“The US market has held up better over the summer because a lot of the headlines that we have had have been Europe-centric,” said a head of European syndicate at a UK bank in London.
Pricing leverage, however, is expected to sit in US investors’ hands rather than with European banks when it comes to Yankee AT1s.
Although the lack of Additional Tier 1 issuance in the Yankee market will work to some extent in the borrowers’ favour, US investors are aware of the mountain of capital the European banks need, at an estimated 25bn-equivalent of Tier 2 and Tier 1 issuance between now and the end of this year.
“The European banks have a lot of wood to chop here,” said a head of trading at a global asset management firm. “At the beginning of the year, we estimated that they had about the equivalent 250bn of capital to raise in a three-year period, and our feeling is that supply will come faster than everyone thinks.”
Supply could also end up being squeezed into just a few months, given that many banks are likely to wait until the ECB’s Asset Quality Review is completed in mid-October.
When it comes to debating new issue concessions, US investors might also argue that dollar-denominated AT1s are highly correlated to junk bonds and equities, and suffered considerably as a result of the recent sell-off in the high-yield market.
“The US bank preferreds have performed much better through the past bout of volatility in high-yield,” said the buyside trader. “It feels like the US bank prefs are more correlated to rates, and European AT1s are more susceptible to flows.” (Reporting by Danielle Robinson, Helene Durand, Editing by Philip Wright)