Downside risks return to the fore after resurgent primary phase for FIG issuance

The first euro benchmark AT1 deals of the year have successfully hit the market amid a string of FIG trades, as issuers have sought to take advantage of a recovery in sentiment to get ahead in funding plans. But with spreads having now largely recovered and downside risks imposing themselves, the tone may turn tougher. Neil Day reports, with insights from Crédit Agricole CIB syndicate and strategists.

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Financial institutions enjoyed resurgent primary markets coming into April, as markets rebounded from wides and investors put cash back to work, but last week there were signs of sentiment turning, as spreads neared early-year tights, and risk factors could regain the upper hand.

After a tentative restart of FIG supply on 14 March — when Crédit Agricole and UBS sold the first senior preferred and HoldCo issues, but in maturities limited to three years — the recovery gradually gathered momentum to the extent that on 23 March Intesa Sanpaolo was able to print the first euro benchmark Additional Tier 1 (AT1) of the year.

The Italian national champion priced its €1bn perpetual non-call 6.5 issue, rated Ba3/BB- (Moody’s/Fitch), at 6.375%, following initial price thoughts of the 6.625% area on the back of some €3bn of demand, with the final reset spread of 556bp over mid-swaps representing a new issue premium of around 25bp.

The market has since proved accommodating to AT1 from diverse credits, namely Deutsche Bank, Rabobank and Banco BPM.

Deutsche Bank issued its €750m perp non-call seven AT1, rated Ba3/BB-/BB, on 28 March at 569bp over mid-swaps and 6.75%, following IPTs of the 7.125% area and on the back of an order book of some €5.7bn — the German, like Intesa, paying a NIP of around 25bp. Rabobank sold its €1bn perp non-call 7.7 AT1, rated Baa3/BBB (Moody’s/Fitch) on 30 March, paying 4.875%, equivalent to 372bp over, mid-swaps following IPTs of the 5.375% area and with a book of over €6bn helping the Dutch bank limit its NIP to around 12.5bp.

And Banco BPM on Tuesday issued a sole-led €300m perp non-call five AT1, rated B3/B (Moody’s/DBRS), at 7% and 604bp over mid-swaps, following guidance of the 7.25%-7.375% area and on the back of €1.15bn of orders.

“The market demonstrated great resilience and capacity to digest more potential bad news from Ukraine,” said Vincent Hoarau, head of FI syndicate at Crédit Agricole CIB (CACIB), “and has been getting used to the concerning inflation figures and their impact on the pace of rate hikes in the US and Europe.

“Globally, the market was less volatile — investors were ready to deploy the solid cash balances they were sitting on and issuers understood that there is a lot of upside in de-risking funding plans before spread potentially widen again and rates go higher.”

The senior non-preferred/HoldCo segment had demonstrated its capacity early on in this phase, with JP Morgan Chase raising €2.5bn in an eight year non-call seven HoldCo deal on 16 March, tightening from IPTs of the 130bp area to 110bp on the back of some €8bn of orders, in a trade that by early last week had tightened to 78bp.

But the recent strength of the market was perhaps best exemplified when BNP Paribas on 31 March approached the market with a 10 year senior non-preferred offering: the long-dated issue attracted some €4bn of demand that allowed it to tighten pricing from IPTs of the 125bp area to 90bp, and come slightly inside fair value. Toronto-Dominion Bank the same day raised €1.5bn of eight year bail-in debt at 80bp over mid-swaps, 20bp inside IPTs and at a NIP of 11bp, after attracting some €2.5bn of orders.

“On a spread basis, we have retraced almost all the losses that occurred from mid-February,” said Hoarau, “but on an absolute basis the yields on offer are much higher than where we were back then, having skyrocketed over the last month.”

The five year swap rate, for example, moved from 0.32% on 1 March to 1% on 1 April.

It has been a similar story in the US market, where spreads and new issue premiums have come down from early March highs.

“Just after the war started and with the Fed having just hiked, the markets were more chaotic and deals were coming to market with 20bp-25bp new issue concession for both Yankee banks and US institutions,” said Daniel Kim, director, US syndicate, CACIB, “as investors demanded an incremental adjustment to reflect the underlying rates volatility — if you look at the two year Treasury, it’s gone from 140bp at the beginning of March to 250bp.

“But as time has progressed, that new issue concession has been averaging 10bp-15bp — much closer to what we saw prior to 17 February and the war — so from that perspective, we have somewhat normalised.”

As in Europe, risk appetite also increased.

“There’s been an incremental move to duration and higher beta names,” added Kim. “There has been a longing for yieldy securities, much of that driven by overseas investors, and we’ve been witnessing outsized demand for 10 year and lower-rated securities.”

On 22 March, for example, HSBC Holdings sold a $2bn (€1.84bn) 4.762% 11 non-call 10 Tier 2, expected ratings Baa1/BBB/A-, at Treasuries plus 240bp, 35bp inside IPTs and with a new issue premium of just 5bp-7bp on the back of more than $8bn of demand. And last Tuesday, as part of a $3.35bn three-tranche trade, Bank of Nova Scotia issued a $1.25bn 4.588% 15 non-call 10 subordinated bond, expected ratings Baa1/BBB+/A (Low) (Moody’s/S&P/DBRS), at Treasuries plus 205bp, 20bp inside IPTs and with a new issue premium in the teens, despite coming in the wake of heavy supply from the jurisdiction.

However, signs are emerging that a turning point is being reached on both sides of the Atlantic, as monetary policy tightening returns to the front page.

On Tuesday, Federal Reserve Board Governor Lael Brainard emphasised the “paramount importance” of getting inflation down, and FOMC minutes released on Wednesday suggested the pace of the Fed’s quantitative easing will be at the faster end of expectations. A 50bp hike is meanwhile considered a near certainty at the 3-4 May meeting, and 25bp or 50bp in June the next of many expected this year.

“This past week, we’ve seen the momentum ease and more of a balance between supply and demand,” said Kim. “The market is realising that the accelerated balance sheet reduction is going to hit the back end of the curve, whereas the shorter end is a little bit more anchored now.

“I wouldn’t say that 10 year demand has been completely eradicated, but we’re getting more demand at the front of the curve — when investors are getting spreads of 75bp to 100bp on a two or three year note, they’re now getting a 3.50% yield, which is pretty good.”

The governing council of the European Central Bank will hold its latest meeting on Thursday and could provide more guidance on when its Asset Purchase Programme will end, as a prelude to a first rate hike. Louis Harreau, head of developed markets macro and strategy at CACIB, expects this to be a 25bp move in December, while the market has been pricing in an outside chance of a 25bp move in September, with 7.5% headline inflation numbers buoying hawks.

According to Hoarau at CACIB, the past week in the euro primary market showed signs of fundamentals reasserting themselves against the liquidity that had been driving the market tighter, as spreads plateaued and investors demonstrated greater diligence on pricing.

“The bounce in risk appetite looks overdone,” he said. “The street is certainly now less inclined to load risk and more inclined to go short, so we are potentially entering a phase of higher volatility in the second quarter.

“Earnings season is starting soon and there is scope for major disappointment in growth expectations — we have already seen the Treasury curve inverting, signalling greater risk of recession. There is still great uncertainty as to how long the war will last and, overall, fundamentals are not rosy at all.”