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Crisis? What crisis?
Number of bond issuances and high demand demonstrate the length investors are going to in order to generate positive returns
18 Nov 2019 | Keith Mullin
Keith Mullin
Keith Mullin

With all that’s going on in the world, you’d have thought investors would be exercising a little caution towards bond issuance. Particularly as year-end approaches. Most investors will have had an OK year so to protect their gains, sitting on their hands might not be the worst strategy – at least until after the start of 2020. But that hardly seems the case.

All-in-all, the global picture is mightily troubling. But taking a glance at just one slice of capital markets activity: European financials issuance as a test case, you’d be hard pressed to know there is anything wrong with the world. And the financial sector is not unique.

Just think of all of the stories being played out in global and regional markets. The ups and downs of the US-China trade story; the more contained Japan-South Korea spat; Germany barely avoiding recession; the ongoing Brexit farce; and a decidedly uncertain expected outcome of the pending UK general election; an election outcome in Spain that was uncertain (the far-right Vox party picking up a huge number of seats and the socialist incumbents forced to make back-room deals with various political forces to form a government).

That’s not all: the gilets jaunes protests continuing in France, huge demonstrations in the Czech Republic on the 30th anniversary of the end of communist rule demanding the prime minister resign over claims of conflict of interest, political and economic crisis in Lebanon, deepening violence in Hong Kong, political chaos in Bolivia following the coup that overthrew the president, widespread violence in Chile, and ongoing war in both Syria and Yemen.

On a less grave note, add into the mix impeachment proceedings against President Trump; slow or slowing growth in much of the world, and stubbornly low inflation. In Europe, the ECB has re-started its bond-buying programme with gusto as part of its ongoing stimulus programme. But there is widespread dissent about the efficacy of its actions – notably from Germany – just as Christine Lagarde takes over the presidency from Mario Draghi.

At a sector level, European financials are generally operating with returns on equity that are in many cases barely covering their cost of equity. There is over-capacity in the sector but bank M&A is a bust. Negative interest rates make it hard to run a bank profitably from a net interest margin perspective. Cost-cutting seems to be the only real game in town to get profitability metrics up, but bank management is struggling to drive down cost-income ratios. Digitalization and branch closures are being addressed by some but probably not the majority of banks. Smaller banks will struggle to generate the financial wherewithal to fund the significant costs of technology investment.

Yet just this month, we’ve seen close to 60 issues in the public bond market from around four dozen units of EMEA banking groups of all colours and hues that have raised the equivalent of US$45 billion. Around 70% of that has been in euros, a quarter in US dollars and a small proportion in sterling.

But what has been more arresting has been the US$80 billion equivalent in demand for financial issuance that emerged in the euro market alone chasing the US$31 billion equivalent sold in the European single currency since the beginning of November. That made for aggregate book coverage of more than 2.5x, with some books ending up very heavily oversubscribed.

That’s pretty impressive for a deeply unsettled market. But if nothing else it demonstrates the sheer hard slog investors are engaged in to do what they can to generate positive returns from negative or super-low yields (other than through price appreciation, which can’t and won’t continue in a straight line).

Sovereign bond yields and swap spreads have edged up in the past couple of weeks, which has helped. The past two to three weeks have been EMEA FIG issuance right across the maturity spectrum; in holdco and opco format; benchmark and sub-benchmark size; and up and down the capital structure – from covered bonds, senior unsecured debt (preferred and non-preferred), through to subordinated and hybrid layers (Tier 2 and AT1).

Issuance has come from G-SIBs, national champions, second-line players, frequent and infrequent issuers, small and not necessarily well known or well followed names, from core, peripheral and emerging market jurisdictions; in conventional as well as green, sustainable and social format. Pretty much everything has been well bid.

Book coverage for issuance lower down the capital structure has been particularly robust given the yield kickers available, although these are reducing are more buyers bid for paper. The 5% yield floor for AT1 issuance has been well and truly breached and a number of issuers have jumped through the window below that level such as France’s Banque Postale pricing its 750 million euro (US$830 million) AT1 on November 14 at a yield of 3.875% to demand in excess of 1.7 billion euros.

Realistically, there are barely four weeks left in the year before things in Europe slow down for Christmas and New Year celebrations and investors start to square off their books.

With the roadshow calendar looking pretty busy in London and other favoured European investor destinations, it looks like the deal printing machine will continue to chug away.

One thing that’s arguably greater than fear of the known is fear of the unknown. Uncertainty is neither the issuer’s nor the investor’s friend. On the basis that things (outside of a current market crisis) can always take a turn for the worse, pragmatism around the status quo, no matter how adverse, tends to be the order of the day.

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