* Senior unsecured bond issuance to fall off a cliff
* TLTRO to have same impact as UK’s Funding for Lending
* Declining funding costs unable to compensate investors for bail-in threat
By Aimee Donnellan and Gareth J Gore
LONDON, July 25 (IFR) - Banks are likely to shelve plans to sell senior unsecured bonds, with bosses opting to save money by replacing private funding with much cheaper emergency loans from the European Central Bank designed to spur lending.
Under the so-called targeted longer-term refinancing operations launched by the central bank last month, eurozone banks will be able to borrow up to 400bn starting in September, paying just 0.25% a year for the privilege - well below what they would pay to borrow in the markets.
This bargain-basement funding is likely to lead banks to pull plans for bond issues.
“The introduction of another LTRO means that unsecured funding levels will drop,” said Damian Saunders, a DCM syndicate official at BNP Paribas.
When the ECB launched the first two LTRO exercises in December 2011 and February 2012, bank bond issuance initially stalled but reignited as spreads tightened.
But this time around investors say they are expecting investment opportunities from eurozone banks to dry up for a longer period of time, leaving the UK and Nordics to carry the primary issuance load. According to market sources, UniCredit and another peripheral national champion are not planning on issuing senior unsecured debt until next year.
Bankers say that financial institutions are likely to grab as much cash as they can from the first two auctions as there will be no stigma attached to reducing their overall funding costs.
“When the news first came out, the consensus among issuers was that they were not going to use it. However, as time has gone on, we get the sense that more will use it than first thought,” said a DCM syndicate banker.
“I would imagine the ECB is very keen for banks to use the TLTRO and will be going on a marketing offensive.”
The ECB’s attempt to encourage banks to lend to small and medium enterprises by providing cheap loans with no strings attached comes at a time when investors are already battling for allocations on rare unsecured bank bonds.
Since the middle of June, only one European bank has issued a benchmark senior unsecured deal, compared with four that came to the market during the same period last year.
And these figures are reflective of a greater trend of declining senior unsecured funding since the onset of the financial crisis as banks aggressively deleverage and lean on the ECB for cheap loans. The slump has dented revenues for investment banks running such deals.
According to Thomson Reuters data, European banks have so far issued about 147bn equivalent of senior unsecured bonds, a slightly higher run rate compared with last year’s total but dramatically lower than supply seen at the height of the credit bubble. In 2007, issuance of senior bank debt reached 318bn equivalent.
This decline in issuance, along with the ECB’s pledge to do “whatever it takes” to support the eurozone, has driven senior unsecured spreads down by more than 100bp in less than a year. And that move will be accentuated if senior issuance dries up even further and a lack of supply distorts prices.
“The financials sector is extremely strong at the moment and could grind tighter as a result of these programmes,” said Neil Williamson, head of EMEA credit research at Aberdeen Asset Management.
“It should help cement the levels we have been seeing over the past few months but that’s not to say that these programmes will somehow fix the market in a way that it won’t experience corrections.”
Over the past year the cost of insuring bank debt as measured by the iTraxx Senior index has more than halved to 66bp (from 135bp).
However, this marked improvement in funding costs is eroding the buffer investors are seeking to cushion them from the risk of bail-ins that could leave them holding nothing.
The recent situation surrounding BES, when the Portuguese government said that a private solution had to be found for a private sector problem, should serve as a stark reminder that senior debt could be on the chopping block in a worst-case scenario.
But in the face of the ECB backstop, European investors say they have little choice but to buy bonds with tighter spreads as redemptions are piling up and they would otherwise miss out on much-needed returns.
One factor that could provide a temporary boost to senior issuance later this year is that banks will soon need to prepare to repay the three-year money they borrowed in late 2011 and early 2012.
While some banks have repaid the money early to rate their financial strength, Spanish and Italian lenders still owe about 350bn borrowed under the first LTROs, which will need to be paid back.
Because of the terms of the new TLTRO, however, many peripheral banks will not simply be able to transfer their borrowing from the old programme to the new. New money is linked to existing lending to the economy, meaning Spanish and Italian banks will only be able to borrow 54bn and 75bn respectively - leaving them with a gap to fill. (Reporting by Aimee Donnellan and Gareth J Gore, additional reporting by Helene Durand; Editing by Matthew Davies)