Italy: SNP buttresses banks’ restoration of ratios
Italian banks have begun taking advantage of senior non-preferred (SNP) debt to help meet rating and regulatory targets as they continue their post-crisis recovery. Wider credit market volatility rather than an inconclusive domestic election has made issuance challenging, but successful deals augur well for an anticipated pipeline of varied supply. Neil Day reports.
If one thing was known for sure before the Italian general election on 4 March, it was that uncertainty would remain after the event. Just how the old wisdom of “buy the rumour, sell the news” would apply to Italy’s poll was therefore an open question.
Ultimately the results did hold some — potentially unhelpful — surprises, but the market took the outcome in its stride.
“We knew that there wouldn’t be a winner — the electoral law was built precisely to prevent anybody winning,” says one market participant. “What was surprising was the polarisation of the outcome — the large success of the two extreme groupings, the Lega and the Five Star Movement, and the losses of the centre parties.
“But what surprised me most — and not only me — was the reaction of the market. We were expecting this hung parliament situation to penalise Italian assets, but this was not the case; the government bonds performed quite well.”
Post-election, BTP yields were lower than at any time this year.
But while the Italian election may not have proven disruptive to Italian levels, the travails of the wider credit markets have taken their toll on supply prospects.
Most publicly, Banca Carige on 27 March said that it would not follow up a Tier 2 roadshow with a deal. The bank had on 16 March announced a European roadshow starting on 19 March for a euro-denominated 10NC5 Reg S Tier 2 issue, with an expected rating of CCC from Fitch.
“The Board of Directors has acknowledged that the market conditions for a subordinated debt issuance on the expected key issuance terms are not yet in place,” said the bank.
However, market participants say that Banca Carige’s fate was not entwined with the wider Italian banking sector’s prospects.
“I wouldn’t take Banca Carige as a proxy of the Italian market,” says one. “It’s a small bank with a difficult story, and so honestly I was not surprised that they had to postpone that transaction.
“The overall credit market conditions have been quite challenging and the appetite for risk has definitely fallen in the past weeks, and if you combine that with the weakness of the Banca Carige rating, the peculiarity of the Italian situation after the election, and the general weakness of credit markets and equity markets, the outcome was not surprising at all.”
The first Italian issuer to test the market after the onset of this bout of volatility was UBI Banca, which on 5 April launched its first senior non-preferred (SNP) issue and only the second such instrument out of Italy.
The Italian government had on 23 December implemented the updated EU-wide bank creditor hierarchy in its 2018 budget law, introducing the new debt category of senior non-preferred (strumenti di debito chirografario di secondo livello) ranking below ordinary claims (crediti chirografari) and above subordinated claims.
National champion UniCredit then on 11 January successfully inaugurated the Italian SNP market with a EUR1.5bn five year deal, attracting some EUR4.5bn of demand from more than 250 accounts to the debut.
The deal took advantage of a positive market tone in the first couple of weeks of the year and improving sentiment towards the UniCredit name. This had been evident a month earlier when on 13 December the Italian issuer had rounded off the first year of a strategic plan with a EUR1bn perpetual non-call June 2025 Additional Tier 1.
“The positive market backdrop and recognition of the ongoing progress of the strategic plan ‘Transform 2019’ has led to a significant repositioning of UniCredit credit profile among the European financial institutions, and the placement of this bond represents a further tangible achievement,” said UniCredit upon making its SNP bow.
Funds were allocated 67%, banks 18%, and insurance companies and pension funds 8%. The UK and Ireland took 22%, France 20%, Italy 15%, and Germany and Austria 10%.
The transaction — rated Baa3/BBB-/BBB by Moody’s, S&P and Fitch — was priced at 70bp over mid-swaps, in from initial price thoughts of the high 80s and subsequent guidance of the 75bp area.
“Helped by the investment grade ratings, UniCredit managed to achieve very attractive pricing,” says Maurizio Gozzi, managing director, DCM, at Crédit Agricole CIB (CACIB), “and the deal performed well post-launch, so their approach was vindicated.”
UBI debuts in senior non-preferred
UBI Banca took the plunge with its debut senior non-preferred issue on 5 April, having spotted a window of stability amid the changeable markets.
“We had been monitoring the market for some time,” says Giorgio Erasmi, head of funding at UBI Banca (pictured below). “The situation had been volatile and weakening, but we saw a day with positive equity markets that could be used.
“We have in our plan different issues across the year and were keen, if possible, to launch this inaugural deal ahead of our blackout period later in the month. It is still not a very easy market, but we are happy with our success.”
UBI’s leads went out with initial price thoughts of the mid-swaps plus 145bp area for the five year deal citing a benchmark size. After around two hours the books were above EUR750m and another couple of hours later, with books above EUR1bn, the spread was set at 140bp over mid-swaps. Two hours later the deal was launched with a EUR500m size and books at around EUR1bn.
Vincent Hoarau, head of FIG syndicate at Crédit Agricole CIB, highlights the level achieved by UBI versus senior preferred levels, putting the subordination premium paid at 35bp-40bp – not far off what UniCredit achieved in more benign market conditions. The 140bp re-offer spread also compares with a Tier 2 level of around 300bp for UBI 10 year non-call fives callable in September 2022 — meaning the bank achieved a much larger saving versus Tier 2 than its bigger compatriot, whose comparable Tier 2 was trading at around 185bp.
“A transaction size of only EUR500m at this level is a very good deal for investors, while 150bp inside the Tier 2 curve is a strong achievement for the issuer,” says Hoarau. “UBI Banca achieved a very competitive credit spread differential versus investment grade-rated peers.”
Italian investors took 50% of the issue, France 21%, Germany and Austria 10%, the UK 7%, Spain 7%, Switzerland 4%, and others 1%. Fund managers and private banks were allocated 62%, banks 26%, and insurance companies and pension funds 12%. Some 130 accounts participated.
Although rated investment grade by Fitch and DBRS, at BBB- and BBB (low), UBI Banca’s SNP paper is rated sub-investment grade by Moody’s and S&P, at Ba3 and BB+.
“It was a very positive result to see the book over EUR1bn in this market and with this instrument’s split rating,” says Erasmi. “It was an important test and we have been happy to see that there is broad demand from investors even despite the split rating.”
Retail rating drivers
While the new class of Italian debt has been introduced in line with EU MREL requirements — and TLAC requirements, for the only Italian G-SIB, UniCredit — UBI Banca’s initial issuance was ratings-led, according to Erasmi.
“At the moment, this new instrument is going to be used in the liability structure to give support to the rating of senior preferred, according to the rating agencies’ criteria,” he says.
Moody’s, for example, had previously flagged the evolution of senior debt as a potential drag on the issuer’s rating.
“UBI Banca’s senior debt rating could be downgraded if a reduction in the volume of senior debt outstanding is not offset by new issuance of senior and/or subordinated debt so that current loss-given failure (LFG) is preserved for these securities,” it said in a 2017 rating update.
Leading to a potential contraction of senior debt among Italian banks is the redemption of bonds that were in the past sold to retail, a practice that has been curtailed due to the now bail-in-able nature of senior debt being deemed inappropriate for such investors. This led Moody’s to take rating actions on certain Italian banks last year.
“Moody’s LGF methodology is penalising the Italian banks that are not rolling the senior unsecured bonds that are maturing,” says Gozzi at CACIB. “Thanks to the TLTROs, they don’t need the liquidity, and because they need to improve profitability, banks are tending to roll these maturing senior retail bonds into asset management products to catch the upfront fees instead of an interest margin that is not so rewarding in the current interest rate environment.
“So on the one hand they are improving their profitability, but on the other they are receiving pressure from Moody’s methodology.”
Filippo Alloatti, senior credit analyst at Hermes Investment Management, says that Moody’s LGF methodology is problematic for most of the second tier banks, deprived of a sizeable senior buffer.
“Yet with UniCredit the rating agency took a forward-looking approach in terms of future issuance,” he adds, “and the Baa3 rating for its senior non-preferred made it eligible for investment grade indices.
“Banks such as UBI (whose SNP rating by S&P is BB+), Mediobanca and Banco BPM, BPER or even Monte will be watching such developments closely.”
Some EUR5bn of UBI Banca senior retail bonds fall due across 2018.
“There are important maturities of retail bonds, and, given the bail-in rules, in our industrial plan we will rely more on the institutional side for bonds,” says Erasmi. “Given the volume of the expiring retail bonds, we will issue on the institutional side both covered bonds and senior preferred and, for smaller amounts, senior non-preferred.
“Issuing the senior non-preferred builds up the support for a buffer under Moody’s LGF methodology that enables us to maintain two notches of support above our BCA [ba2] for the rating of our senior preferred [Baa2], even after the significant maturities on the retail side.”
A menu of instruments
Despite UniCredit having moved quickly to open the Italian senior non-preferred market, expectations regarding supply of the new instrument are balanced.
“After the inaugural transaction from UniCredit in January, Italian banks are ready to jump on the senior non-preferred bandwagon,” says Alloatti at Hermes. “Yet in terms of supply — with Intesa having shown little interest for tapping the SNP market this year and UniCredit recently hinting of not being into a rush to complete the issuance of remaining EUR5bn and potentially be absent from the SNP market for the rest of the year — the supply should be limited.
“Sure, if we look at the UniCredit SNP the premium over the preferred senior of less than 30bp at issuance make the instrument a lot more compelling than the classical Tier 2. Yet existing Italian preferred senior, as junior-ranking to the whole deposit stock, will most likely qualify for MREL eligibility.”
At UBI Banca, Erasmi says the final size of its senior non-preferred issuance will be analysed once the bank has more details about its MREL requirement.
“But having started early and with no rush, I would imagine having not only the one senior non-preferred issue this year, but more, even if in a very opportunistic way,” he adds, “so a part of this buffer in our view could be in the future built through senior non-preferred.”
UBI plans to achieve a core equity tier 1 ratio of 13.5% in 2020, up from 11.4% today, with its total capital ratio set to rise from 14% to around 17%.
“At the moment, there are no public MREL numbers — we understand the requirement could be in an area of roughly 22%, 23% for banks like UBI Banca,” says Erasmi. “That implies that maybe 5% or 6% of the MREL requirement could be fulfilled in part with senior non-preferred.”
Domestically systemically important banks (D-SIBs) Intesa Sanpaolo, Banco BPM and Monte dei Paschi di Siena will meanwhile have to factor in other capital requirements.
“Senior non-preferred is MREL eligible and can be very helpful in matching subordination requirements within MREL,” says CACIB’s Gozzi, “but for the time being the regulator is still not sending out this requirements. The D-SIBs should receive it sooner rather than later, while the others it could be a year-end exercise or even next year.
“So the instrument that may turn out to be more prevalent in the short term will perhaps remain senior preferred, i.e. the old senior unsecured format, which banks may find the cheapest way to retain the buffer required by Moody’s.”
He further notes the importance of more than EU200bn of TLTRO repayments in determining supply dynamics — even if much of this will not need to be refinanced.
“This will be starting in mid-2019, but the bulk of TLTRO redemptions in Italy — and across Europe —is in June 2020. However, because the monies are only included in the NSFR ratio until a year before maturity, we could see banks beginning to prefund this from next year to avoid a cliff effect — although not yet this year.
“The main instruments for replacing the TLTRO money will probably be covered bonds, the cheapest in the market, but why not senior preferred?”
Find out La Banque Postale Asset Management’s view on Italy’s “two-speed” banking system here.