August 8, 2014 / 8:27 AM / 3 years ago

Dicey market conditions eyed ahead of September capital rush

* Investors expect 25bn of Additional Tier 1 and Tier 2 issuance

* Banks could revive old mandates

* Regulatory warnings do little to quell investor appetite

By Aimee Donnellan and Helene Durand

LONDON, Aug 8 (IFR) - European banks are facing serious headwinds as they seek to offload billions of deeply subordinated debt in September after the wipe-out of Tier 2 holders in Banco Espirito Santo triggered a mass sell-off in the market.

Since the beginning of the year, investors have shown insatiable demand for banks’ most deeply subordinated debt as they have sought to lock in high returns.

However, the resolution of Portuguese lender BES that left the Tier 2 bondholders stranded in the bad bank has acted as a painful reminder of the risks attached to the asset-class while UK and European supervisors warn the market that these instruments are not suited for all investors.

“There are several transactions that we were looking to execute before the summer break but were delayed because of market conditions,” said Gerald Podobnik, head of capital solutions at Deutsche Bank.

European banks sold a total of 39.3bn-equivalent (US$52.6bn) through 32 issues in the first half of 2014, three times as much volume as in the first six months of last year, according to Thomson Reuters.

Investors are expecting around 25bn-equivalent worth of supply for the rest of this year, but bankers warn that supply could get off to a slow start in September.

“The market is likely to remain difficult even in September so we need the right banks to come out first,” said one DCM banker.

“The others really won’t have much time as I don’t think many of the weaker banks will want to go head-to-head with the AQR.”

The European Central Bank is to enter the final phase of a balance sheet health check of the region’s lenders in October.

The comprehensive assessment, conducted by the ECB before it starts supervising the eurozone’s top 120 banks from November 4, will examine banks’ balance sheets and weigh up their ability to withstand shock and stress.

CLEARING A PATH

For the most part, the path should be clear for capital issuance. Cheap funding through the TLTRO is likely to quell senior unsecured issuance and banks are trying to keep their covered bond collateral dry for times of extreme market volatility.

According to bankers, as much as five deals that were due to come before the summer have been delayed and there will be new ones that are added.

“We expect the pace of issuance to be similar to what we had before the summer and capital to continue to be a big theme in the second half of the year,” said Deutsche Bank’s Podobnik.

Expectations are that banks in jurisdictions that have already been active, such as Spain and Italy, will look to return, but many hope that Scandinavian, Austrian and Dutch banks will finally open up, while more supply from Germany could emerge.

Possible contenders include German property lender Aareal Bank, which could revive plans for a CoCo having shelved a deal in late July citing unfavourable market conditions.

Austrian lender Raiffeisen Bank International has indicated it would look to raise AT1 before and could finally emerge. Italy’s Intesa could also follow in the footsteps of UniCredit, which issued the country’s first Additional Tier 1 bond in March.

And Banco Popular Espanol could also raise capital having yanked its CoCo from the market in early July.

LATE TO THE PARTY?

But all of these banks will have to dodge volatility that has led to a eight point sell-off in just two months.

For example, Deutsche Bank’s euro Additional Tier 1 bond was quoted at 96 earlier this week, according to Tradeweb, way off the 104 cash price it was at before the BES scandal hit the market.

European supervisors, moreover, are adding fuel to the sell-off fire as they seem at pains to remind banks of the dangers of selling junior debt to retail accounts.

In a statement released on Tuesday, the UK’s Financial Conduct Authority (FCA) said it would bar UK banks from offering risky and complex hybrid debt to the mass market from October.

Meanwhile, the European Banking Authority has sent out a reminder to financial institutions of their responsibilities when placing financial products with investors.

The Joint Committee of the European Supervisory Authorities (EBA, EIOPA and ESMA) highlighted specific risks posed to investors by contingent convertible instruments (CoCos).

While this is hardly new, investors believe the sell-off in Additional Tier 1 bonds has little to do with regulators’ opinions but a lot to do with market volatility.

“We’re holding off taking positions in CoCos until September, when primary issuance restarts and there is more liquidity in the market,” said the portfolio manager.

“As far as the reminders from regulators are concerned, considering the denominations these bonds are sold in, I don’t think it’s really a concern,” he said.

Bankers share that view and believe that the warnings from the EBA and FCA are unnecessary given the parameters of the market.

“This is not unexpected,” said a hybrid banker.

“The transactions executed over the past two to three years have generally been institutionally targeted and issued with high (100k+) denominations.” (Reporting by Aimee Donnellan and Helene Durand; Editing by Sudip Roy)

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