First Abu Dhabi Bank cheered emerging market bond investors with a debut tier two issue last week. Although it cost more than its senior debt, the trade was a reminder that when issuing bonds, cost is not everything.
As subordinated debt, the tier two was more expensive for FAB than its previous senior bond issuance — the difference between the two was about 100bp.
That higher cost may suggest that subordinated debt is a product that issuers should only target if they really have to. Banks have capital requirements to meet but FAB, and many other banks from emerging market countries, have managed to meet those without issuing subordinated debt.
So why is FAB's deal a positive rather than simply a case of a borrower issuing debt for the sake of it?
Firstly, it delighted its investors, who want to see more subordianted bank debt from the Gulf region. Buyers got their mitts on A-rated exposure paying a chunky yield, an extreme rarity.
Giving investors what they want is a sensible long-term strategy — delight your customers, as Warren Buffet famously urged — even if it is a bit more expensive than an issuer is used to.
Cost of funding is important, but it is not everything. There is reputation to consider and investors will flock to open credit lines for issuers that treat them well. Extra demand in the long-run will push down the cost of borrowing, all other things being equal.
Gulf banks understand how important the relationship between issuers and investors is — one investor told GlobalCapital that they value their reputations almost above anything else.
There are only a few CEEMEA banks who would be able to issue such subordinated bonds but those that can should learn from FAB’s success.
Beyond subordinated
It's not just an argument that applies to subordinated debt either but to every variety of bond, including those with ESG labels.
New products take time and money to develop and construct, let alone find the right time to issue. It can take years to prepare a new bond in a new format.
The pay off down the line is apparent in ESG bonds. A green finance framework, for example, will cost a lot of money and time to develop. But the issuer not only does an issuer reap a cost benefit, through the so-called ‘greenium’, but it expands its audience of delighted investors.
GlobalCapital argued last year that the time and expense required to enter new markets is worth it, specifically with regard to issuing in new currencies. It takes a lot of effort, particularly if you want to issue in a market like Japan's, for example, but that hard work can pay off.
Achieving investor diversification for EM issuers is especially important in an era of rising interest rates, which has presented problems of market access to a number of them.
If an issuer only has one pool of liquidity to access on the bond market then they are at the mercy of one group of buyers.
New products like a subordinated bond, a green bond or a Samurai open up new avenues, which is vital when liquidity is not as abundant as it once was.
FAB took a bold step last week in opening up a new market for itself. Borrowers that adopt a similarly pioneering approach will benefit for years to come.