NEW YORK/LONDON, Oct 21 (IFR) - US banks unleashed a torrent of callable senior debt in dollars and euros this week, finding strong investor demand for the structure, which is designed to cut the cost of new regulations.
Banks issued more than US$10bn equivalent of senior debt with call options one year before maturity - intended to allow them to redeem the debt before it stops counting towards their Total Loss Absorbing Capacity requirement.
Market participants said the structure was clearly now accepted by investors and issuers alike - despite the fact that the Federal Reserve has not yet released its final TLAC rules.
“It is here to stay,” said a syndicate banker involved in one of the deals. “It will be a large component of US bank issuance going forward.”
Most issuers stuck to dollars but Goldman Sachs proved there was demand across the pond too with a 1.25bn 8.5-year non-call 7.5-year deal.
In dollars, JP Morgan returned - after it opened up the market in August - printing US$2bn in 7nc6 floating rate format, while Bank of America Merrill Lynch printed US$5bn across 7nc6 and 11nc10 and Morgan Stanley a US$2.5bn 7nc6 FRN.
The week’s deals bring the tally for TLAC-efficient senior issuance to just over US$18bn.
“Banks are pushing ahead with this,” said a FIG DCM head. “I haven’t heard that any of them have gotten sign-off from the Fed, but technically these deals do fit the proposed rules.”
Under the proposed rules, debt receives 50% less TLAC treatment when it has less than two years until maturity, dropping to zero when it has less than one year remaining.
Call features would theoretically allow issuers to redeem bonds early, before they lose TLAC treatment. That would save them paying interest on debt with no regulatory benefit.
The final rules are expected to be released later this year, so there is still a chance regulators could veto callable structures for TLAC purposes.
“You could conjecture that if you issue enough of it, you’re putting pressure on people to allow it,” said one banker.
Wells Fargo, Bank of New York Mellon and State Street are the only banks subject to TLAC that have not yet tapped the callable structure.
Market participants said banks that have not yet issued the callable structure would be under pressure to do so.
“You’ll have to explain why you’re not doing them, because they are more efficient,” said another FIG DCM head.
JP Morgan paid up handsomely to bring the first TLAC-efficient deal in August, paying around 25bp over its outstanding five-years for its inaugural US$2.5bn 5NC4 deal.
The price of the call option has come down since then, however, and deals are now pricing in line with or inside bullet structures with the same maturity.
JP Morgan’s latest issue priced in line with its outstanding bullet seven-year bonds.
An identically structured deal Citigroup sold nearly two months ago offered around 5bp of premium over the bank’s outstanding seven-year bonds.
Floating rate notes have proved popular in the structure, with bankers putting that down to the difficulty of swapping fixed-rate callables back to floating.
“Not every organization has quite got there with their ability to swap the fixed to floating with the call,” said a senior FIG banker.
Goldman paid a premium to enter the euro market with the callable structure this week but bankers said that was inevitable and that they had found crucial pockets of demand.
“Feedback so far in Europe is a bit mixed,” said a FIG banker in London.
“We’ve had quite a few calls from European investors saying we can buy this, but some PMs have internal processes to get it approved, or can’t treat it as usual senior.”
The response to Goldman’s deal sent a positive signal, with final books for the 1.25bn 8.5nc7.5 reaching 3.5bn from over 250 accounts.
“It’s the regular set of buyers, there’s no specific push back on this,” said a banker close to the deal early on Thursday.
Bankers pegged fair value for a straight 8.5-year senior around swaps plus 95bp, but some investors treat the call date as the final maturity making the spread on offer look more attractive. The one-year extension is worth around 10bp.
“Given the high probability of being called, we generally look to pricing relative value over the call maturity, although the deals are priced over final maturity,” said Steve Hussey, head of financial institutions credit research at AllianceBernstein.
One banker away from the trade said TLAC callables could be interesting for European banks.
“I wouldn’t exclude European banks trying to do this, given that the last year can be inefficient from a TLAC perspective, though it’s still funding,” he said.
“However, they will only do it if it’s not more expensive. I would argue Goldman Sachs has shown that there isn’t much of a premium versus a bullet.”
The structure may take longer to catch on among European banks, though, given the more varied regulatory regimes in the region.
UBS comfortably sold a 1.25bn 10-year senior holdco bond in August with a call three months prior to maturity to help manage its Liquidity Coverage Ratio.
However, many believe longer calls are unlikely while European resolution regimes and regulatory approval remain up in the air. (Reporting by Will Caiger-Smith and Alice Gledhill; Editing by Alex Chambers and Sudip Roy)