It has been a tough year for many in fixed income. According to financial information provider SNL Financial, total first-half FICC revenue has declined 9% year over year for both the European and the US banks.
Indeed, fixed-income revenues for the second quarter of this year declined versus Q2 2013 at all but a handful of leading banks.
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| The stress tests are not a big trigger for supply – issuers need to be more focused on disclosure prior to release of the stress-test results Christoph Hittmair |
Barclays’ credit and macro business was down 16.59% in fee terms, Citi’s fixed-income markets business fees fell 12.45%, the FICC fee revenues of Goldman Sachs and Morgan Stanley were down 9.74% and 12.6% respectively. HSBC saw credit, rates and foreign-exchange fees fall by 9.79%, while fixed-income markets revenue at JPMorgan were down 14.62%.
It wasn’t all bad news. Fixed-income sales and trading revenue was up 13.6% at Credit Suisse, debt and other products scraped a 0.16% fee increase at Deutsche Bank and Société Générale (SG) saw FICC revenues rise 9.03%. UBS’s foreign exchange, rates and credit business was also up 8.84% year on year in fee terms.
FIG has historically been one of the biggest fee generators for many banks’ fixed-income businesses, but has struggled in the face of the myriad problems the sector has faced since 2007. It is no surprise, therefore, that many FIG teams are now intensely focused on an anticipated surge in AT1 issuance running to year-end.
AT1 deals are more lucrative than almost any other part of DCM and banks are scrabbling to secure their piece of the action. With $12 billion of supply now anticipated from two Chinese banks alone – Bank of China and ICBC – together with a €15 billion to €20 billion surge in supply after the publication of the European bank stress-tests results on October 24, there is plenty for the market to get its teeth into. Indeed, according to CreditSights further issuance potential for new style AT1 up until 2021 amounts to €200 billion.
However, matching these kind of flows with investor demand will be a tricky task.
“The big question in AT1 is how the market deals with supply,” says Jonathan Weinberger, head of capital markets engineering at SG CIB. “Buyers are being more cautious in the face of the supply for the rest of the year, but there will not be a qualitative change in the way that investors view these instruments.”
Alarm bells ringing
The reception afforded to Santander’s €1.5 billion perpetual non-call seven AT1 trade in early September set some alarm bells ringing among underwriters: the deal attracted an order book of just €3.75 billion compared with €17 billion for the Spanish bank’s inaugural trade in March. Offering 6.25%, it also struggled in the aftermarket.
Nerves were restored, however, after two successful debut deals later in the month from solid investment grade issuers – HSBC and Nordea. HSBC’s triple-B rated issue was split between $3.75 billion in non-call five (5.625%) and non-call 10 (6.375%) notes and a €1.5 billion 5.25% non-call eight tranche. It attracted an order book of more than $30 billion.
Nordea’s $1 billion perpetual non-call five tranche the following week offered 5.5% while a $500 million perpetual non-call 10 tranche offered 6.125%. The deal attracted a $10 billion order book.
This suggests both a flight to quality among investors and that anticipated supply is giving investors the luxury of sitting on their hands. HSBC has indicated it expects to issue $20 billion AT1. The order books for both it and Nordea’s bonds might also suggest that investment-grade deals will attract a new buyer base for AT1.
| There is no doubt that there is sufficient liquidity in the AT1 investor base – any questions over this have been laid to rest Barry Donlon |
“Most big investors that participate in the AT1 market buy across the spectrum from non-investment grade to investment grade – they have pockets to fit these instruments into,” explains Christoph Hittmair, head of European FIG DCM at HSBC.
“Therefore, in terms of attracting new names, there were some new names that did participate because the deal was investment grade, but there were not a huge number of new names – but this is what the issuer was expecting.”
He also explains that rating is less of a concern for many buyers than the order book would suggest.
“There is not a seismic shift in the order books because it is investment grade,” says Hittmair. “However, the investment-grade rating was a bonus and underlined the strength of the credit, which was helpful for the dynamics of the transaction.”
The nature of AT1 instruments themselves will put a natural brake on investor participation. “Some investment-grade investors have different considerations,” he adds. “It is not so much whether AT1 product is investment grade or non-investment grade – certain investors cannot hold AT1 structures due to their equity conversion or write-down mechanism regardless of the rating.”
Nordea’s non-call five bonds carried the lowest coupon to date for AT1 securities. This will necessarily force the transition of the investor base away from the type of buyers that were active in the market in its early stages.
“With AT1 now yielding 5% to 6% in Europe, the return falls significantly below the returns targeted by hedge funds,” explains Barry Donlon, head of the capital solutions group EMEA at UBS in London. “Many such funds are therefore moving from the AT1 market into bank equity.”
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He has no doubt, however, that investor appetite will be more than sufficient to cope with the pipeline.
“There is now a significant pool of US onshore capital that missed the distressed opportunity in Europe and is now targeted at AT1,” says Donlon. “There is no doubt that there is sufficient liquidity in the AT1 investor base – any questions over this have been laid to rest.”
Hedging considerations
Both HSBC and Nordea issued in dollars – but Donlon explains this will likely remain the preserve of the larger European banks due to hedging considerations.
“As AT1 is difficult for some borrowers to hedge, many domestically focused banks will issue in their core currency,” he says. “Dollar issuance will therefore be skewed to the larger banks with dollar assets on balance sheet. Smaller European banks will have to rely more on domestic demand in euros.”
Although regulatory and tax clarity in jurisdictions such as the Netherlands, Germany and the Nordics has stimulated European bank issuer interest in AT1, the results of the region-wide asset-quality review (AQR) stress tests could trigger a flood of deals before year-end.
And, particularly after the market’s recent bout of nerves, these are likely to be from the better-quality banks.
“Issuers are being advised to wait until after the results of the AQR stress tests before they come to the market,” says SG’s Weinberger. “Those banks that are demonstrated to be pretty solid will be the first to come to the AT1 market after the results of the tests.”
However, Hittmair at HSBC warns that the process of issuance around the tests will have to be managed carefully.
“The stress tests are not a big trigger for supply – issuers need to be more focused on disclosure prior to release of the stress-test results,” he warns. “Banks will be receiving preliminary information from the regulators on their own stress-test results. They will need to determine how material this information is prior to a new issue and whether it needs to be disclosed.
“At the same time, regulators do not want the banks disclosing information on the stress test ahead of the official release of the data.”
