Primary execution improves after subdued New Year start, as supply collapse hits home

The euro primary market last week recovered from a lacklustre opening, with financial institutions now able to take advantage of a severe supply-demand imbalance and benign conditions, and subordinated instruments finding most favour. Neil Day reports, with insights from Crédit Agricole CIB trading and syndicate in London and New York.

Yellen Biden web

You can also download a pdf of this article here.

After an uncertain start to 2021 for the euro FIG market, the true extent of supply-demand dynamics hit home last week as issuance dried up, allowing for the new year’s deals to perform and providing fertile ground for those banks approaching investors with trades.

From 13 January until Friday (22 January), only two new benchmark financial institutions issues hit the euro market, a €500m 10 year senior preferred issue for Erste Group Bank last Monday and a €1.75bn seven year senior HoldCo trade for Goldman Sachs on Thursday.

Supply of euro senior preferred/OpCo and senior non-preferred/HoldCo paper of €5bn and €10bn, respectively, is roughly half that of the first three weeks of January 2020. The contrast in more deeply subordinated instruments is even more stark, with year-to-date Tier 2 supply of €500m barely 10% of last year’s €4.65bn, and AT1 issuance of €775m is down sharply from €2.8bn at the start of last year.

Although supply had been expected to be depressed, the first senior deals of the year achieved lower oversubscription levels — of around one and a half times — and slightly higher new issue premiums — around 5bp — than those typical of the second half of 2020.

“Despite the steady start to the year, pricing momentum was sometimes limited, and we did not see any proper blow-out in the euro senior unsecured segment,” said Vincent Hoarau, head of FIG syndicate at Crédit Agricole CIB. “We need to bear in mind that we have come a very long way throughout the pandemic and valuation are extremely rich, and most of the time we are already back to pre-Covid levels.”

This was borne out by a €2bn dual-tranche senior preferred deal BPCE sold on 5 January, almost exactly a year on from a €2.25bn deal in 2020. A €750m six year tranche was priced at mid-swaps plus 48bp and a €1.25bn 10 year at plus 60bp, very close to January 2020’s €1.5bn five year at 45bp and €750m 10 year at 55bp, while the re-offer yields were lower, at 0.032% and 0.325% versus 0.308% and 0.66%, respectively.

“Yields are negative in a big portion of the senior unsecured market,” added Hoarau (pictured), “so it is not too big a surprise to acknowledge that books were slow to build in the lower beta end of the capital structure, with investors forced to buy in primary while lacking conviction.


“The higher beta the format and/or credit, the bigger the order-book and the greater the price traction. Investor behaviour validates our belief that scope for performance and spread compression is only left in higher beta instruments.”

Indeed, the highest oversubscription among 2021’s year-to-date euro FIG supply was achieved on a €375m perpetual non-call 5.5 AT1 for Abanca on 7 January, whose €1.8bn book at re-offer was also larger than some of the senior benchmarks’ on an absolute basis. The strong demand — above €2.1bn at its peak — allowed for pricing to be tightened from mid-to-high 6% down to 6%, with fair value put at around 6.25% by the leads, and for the size to be upped from an initially announced expected €350m.

André Bonnal, FIG syndicate at joint bookrunner CACIB, attributed part of the success of the trade to two days of premarketing before launch that encompassed around 40 accounts.

“It’s a very good bank, but not the name you would expect to reopen the subordinated space in euros,” he said. “It was really a question of considering the pros and cons of aiming for the first week versus waiting and risking more competing supply. While we were all expecting supply to be on the low side, it wasn’t apparent that we’d see as little as we got.

“In the end, it played out very well. Some parts of Europe were on holiday the day before launch, but it gave us another day to gather strong indication of interest from UK and French investors and we knew we would have a very well bid transaction the next day.”

See Abanca Q&A for full coverage.

Banco Sabadell followed its compatriot into the market the next day (8 January) with the first euro Tier 2 of the year, a €500m 10 non-call five also jointly led by CACIB. Following initial price thoughts of the mid-swaps plus 330bp area, the deal was priced some 10bp inside fair value at 295bp on the back of a €1.4bn book, its 2.8 times coverage at the upper end of FIG supply.

“AT1 is the only part of the capital structure that still trades wide of pre-Covid levels,” said Bonnal, “and while Tier 2 may be flat to where it was, investors prefer it to the tight levels at which senior preferred and non-preferred trade — it’s the next best thing they can buy while retaining in many cases an investment grade rating.”

New issues rebound amid shortage

With equity markets weaker and government bond yields rising, the market entered the second week of the year on a softer note, and then Banco BPM approached the market on 12 January with a €400m perpetual non-call five AT1 just as the ruling Italian coalition government was threatening to fall apart. The transaction was priced in the middle of IPTs of the 6.5% area on the back of a €560m order book.

The underwhelming reception of new issues and their underperformance then contributed to the subsequent pause in euro primary market activity.

“Issuers are in comfortable positions in terms of liquidity,” said Bonnal, “and they didn’t feel they needed to rush into primary in January, especially as some of the new issues were struggling in the secondary market.”

However, the subsequent pause in supply until last week and limited new issuance thereafter — with European banks entering blackout periods — only served to support the performance of the year’s early trades.

“As macro conditions turned, most of those deals struggled quite badly, trading wide to re-offer,” said William Rabicano, director, credit trading, at CACIB. “But the expectations of additional supply simply didn’t materialise, and the new issues are now all trading back inside re-offer and outperforming.

“So there’s still cash to be put to work and the sheer lack of issuance means that any deals that come now will be well received and won’t have to pay much in the way of new issue premiums.”

This was evident in Goldman Sachs’s euro benchmark seven year senior HoldCo on Thursday, where pricing was tightened from IPTs of the mid-swaps plus 90bp area to guidance of 70bp+/-2bp, WPIR, on the back of €3.75bn of orders, before the deal was sized at €1.75bn and priced at 68bp on the back of over €4bn of demand.

“They had a book above €2bn by around 9am UK time, whereas the earlier SNP trades were at around €1bn at the same stage of the process,” said Bonnal. “Everyone played in that trade and it’s the first proper big book we’ve seen year-to-date in seniors. It just shows that the market is craving supply.”

Rabicano nevertheless noted heightened price sensitivity among investors, highlighting that books on Erste’s €500m 10 year senior preferred benchmark last Monday fell from €1.7bn-plus at its 55bp-60bp over mid-swaps guidance to above €1.2bn at its 55bp re-offer.

“It had a reasonable book, but this dropped dramatically on final terms,” he said, “so it seems that investors are going to be much stricter on where they are happy to own these new deals, and people are going to drop if they are tightened too much.”

Volatility low as risks take a backseat

The back-up in yields in US dollars across the first week of the year, with the 10 year Treasury rising from around 0.90% to above 1.10%, has meanwhile led to some selling of dollar AT1 by Asian investors, according to Nigel Brady, AT1 trader at CACIB.

“You are starting to look at a swing in the interest rate environment, with Asian retail tending to prefer equities over fixed income,” he said. “They’re very rate sensitive and also questioning whether 4.5% or 5% for AT1 makes sense when they were buying at 6% to 7% over the last couple of years. They are taking profits where they can and my flows have been two to one in favour of sellers.

“But that’s predominantly the Asian investor base,” he added. “We’ve been able to recycle most of that because on the flipside we’re seeing European and US real money are still very much buyers. They’re still constrained to fixed income and they still need to put money to work, and AT1s are still attractive versus IG and high yield.”

While the euro market — with the exception of the Italian “wobble” — has outperformed the dollar market, Brady said AT1 in general have been very stable.

“Overall, we are in an environment of very low volatility,” he said. “The year to date moves across the board have been very compressed, just plus or minus one point.”

Brady sees a blow-out in rates as one of the only eventualities that could knock the market off course, alongside a correction in equities, but does not anticipate such a scenario.

“And I would expect it to be very short-lived,” he added, “and any dip would be seen as a decent buying opportunity.”

Like Brady, Hoarau sees markets’ January resilience as reflective of their focus on vaccination rates rather than infection rates when reflecting Covid-19 developments.

“Although lockdown is becoming the norm again,” he said, “markets are focusing on the good news, as the reading of the first US non-farm payrolls of 2021 demonstrated: it was the ninth consecutive month of smaller payrolls, but investors focused on the signs of recovery in the readings, even if this is further away, somewhere in H2. Across the board, private sector demand is not there, but governments are doing the job with their budgetary weapons, and on top of that vaccination deployment brings positives into the room.

“There are some valuation concerns,” added Hoarau, “but everyone is cognisant of the liquidity element and imbalance in the supply-demand dynamic, particularly in the FI world. With Biden in office, the political risk premium has disappeared, and more money is on the table with a third stimulus package. And the earnings season should confirm that the micro economy is subsided.”

Regarding risk factors, Hoarau sees two that are not necessarily adequately priced into the market.

“The market isn’t pricing in any probability of renewed tensions between the US and China, so this side of the equation could surprise at some point,” he said. “Same for the German election and potential influence on ECB monetary policy: Germany — and its budget surplus — may not necessary be inclined to further support an expansionary policy.

“But again,” he added, “neither of these are short term risks, and the powerful technical and liquidity supports currently in place are set to support further compression and tight spreads. Short term, we have a set of key inflation data coming out of Europe this coming week that will be scrutinised as it could move the direction of rates.”