FIG issuance in overdrive as market rebuilds after banking crisis

Although the FIG bond market faced moments of great stress and difficulty in 2023, there is reason to believe that it will be better equipped to handle another glut of funding in 2024, according to respondents to GlobalCapital’s outlook survey.

The demise of Credit Suisse, the first collapse of a globally systemically important bank (G-SIB) since 2008, was a pivotal moment for all bond markets and especially relevant to bank funding. Stress in the banking sector and rising interest rates triggered a destruction of value across bonds. Consequently, the market for European unsecured FIG bonds was at times prohibitively expensive for capital raising — and shut altogether for some smaller issuers.

Yet, by mid-November, there had been €250bn of unsecured public benchmark FIG issuance in the single currency — almost 16% higher than the amount raised during the same period of 2022, which turned out to be a multi-year record breaker by the time it was over, according to GlobalCapital’s Primary Market Monitor.

It wasn’t just the euro market that was strong in 2023, either. There were almost £29bn of unsecured sterling sales in the same period, almost identical to 2022.

Unsecured issuance volumes are expected to be similar in 2024, according to survey data and market experts.

“There is no reason to believe that the funding plans of 2024 will be lower than in 2023,” says Vincent Hoarau, head of FIG syndicate at Crédit Agricole. “When you combine senior non-preferred, senior preferred and covered bonds, issuance will be as dense as it was this year.”

Forecasts from UniCredit suggest a similar picture. The bank expects about €220bn issuance in 2024 in senior format, roughly equally split between preferred and non-preferred bonds. In covered bonds, a key funding channel for providing banks with liquidity, UniCredit expects about €180bn supply, which will be in line with or slightly less than 2023.

To reach such volumes, issuers have had to become smarter operators, spotting and then being nimble enough to take issuance windows as they present themselves in a market where they have become scarcer now that the era of cheap central bank liquidity is over. “The market in Europe has learned to be open throughout the year, with issuers adapting accordingly and issuance activity lasting longer,” says Isaac Alonso, head of debt capital markets for Germany at UniCredit.

Issuers had to step up their market funding activity as they repaid central bank borrowing. While most of the European Central Bank’s Targeted Longer-Term Refinancing Operations (TLTRO) has now been repaid, the decreasing presence of the central bank in the bond market is expected to dictate the pace of issuance.

“The market dynamic points in one direction: normalisation,” Hoarau says. “For the first time in a decade we will be starting a year without quantitative easing and central bank purchases. Real interest rates will be positive. The liquidity situation is favourable but overall net supply is set to be positive if you consider growing supranational, sovereign and agency supply and the decrease of central bank balance sheets.”

Despite a growing perception that the US Federal Reserve and the ECB were at or close to their peak interest rates by the end of 2023 — which had improved primary market sentiment since the end of October — higher rates are expected to slow economic activity. This in turn is expected to lead to lower bank lending.

“Rates are expected to stay higher for longer and, in combination with sticky inflation, this points to the first half of 2024 remaining unchanged in terms of the rates outlook,” says Alberto Maria Villa, who heads FIG syndication at UniCredit.

Thus, the growth of banks’ balance sheets “will be limited and the financing of new risk-weighted assets not so pronounced,” Alonso adds.

Still, banks are unlikely to reduce their coveted senior bail-in debt layers that form their minimum requirements for own funds and eligible liabilities (MREL) and G-SIBs’ total loss-absorbing capacity (TLAC), Alonso says. “They will replace calls and keep up the capital stack. But in terms of net new MREL or capital issuance, we see that as very unlikely across the market.”

Hoarau agrees: “Pure liquidity funding will be at the top of everyone’s agenda, while in senior non-preferred it’s more about refinancing the existing stack.”

Against this backdrop, most of the survey’s respondents expect senior spreads to widen.

But Villa is among those expecting a different direction for spreads. He sees them remaining largely unchanged for the first six months of 2024, subject to no drastic shifts in macroeconomics or geopolitics. Then will come a “tightening bias” in the second half of the year, he says.

The jury was still out on which funding instruments banks will choose to concentrate their efforts upon. This is because the health of the covered bond market may sway the course of unsecured issuance.

Nick Hughes, head of capital markets at Lloyds Bank, expects that there will be more senior preferred issuance connected to central bank repayments, “but this will depend on how accommodative the covered bond market will be,” he says.

He expects covered bond issuance to be “modestly lower” in 2024 as central bank repayments will be the “key driver” for the asset class. “Spreads will be a little wider, but they have already moved materially versus govvies,” he adds.

Villa highlights how this widening is another sign of maturity in the European FIG market. “Although next year there will be further repricing of core covered bond jurisdictions,” he says, “these are organic factors in a functioning market rather than external troubles in the system.”

Views on euro capital issuance, unlike on senior bonds, were more diverse.

By mid-November 2023, FIG borrowers had printed about €24.5bn of tier two and €8.9bn of additional tier one (AT1) capital, PMM data shows.

Owing to the expected limitations on banks’ needs for net new capital, UniCredit forecasts that the split will be about €20bn of tier two debt and up to €25bn AT1 sales in 2024.

Villa says that “subordinated issuance in euros looks a little higher [than 2023] but it’s coherent with calls and overall risk management. It will be a market with largely no new risk takings”.

The greater diversity of opinion on the prospects for capital issuance may be linked to spread expectations, which were in sharp contrast to senior debt.

UBS’s spectacular return to the dollar AT1 market in the first half of November — a $3.5bn dual trancher that attracted more than $36bn peak demand — underlined the improved tone for raising capital on the back of the notion of peak rates.

An average yield on AT1 paper of about 11% — roughly translated as 600bp over G3 government bonds — appears to be wide, according to Romain Miginiac, fund manager and head of research at Atlanticomnium. “It’s tough to find something to compare AT1s with where they don’t look cheap, especially historically versus US preferred shares [their AT1 equivalent] or high yield,” he says.

“With fundamentals being strong for European banks, even with peak net interest margins being reached for some, as we saw in their third quarter earnings, we are at a point where there is a huge dislocation of fundamentals and valuations,” he adds.

This, despite UBS’s success, shows that some damage has remained unhealed in the secondary AT1, which Miginiac describes as “tainted by what happened with Credit Suisse”.

The Swiss regulator’s decision to wipe out Credit Suisse’s $17bn-equivalent of AT1s during its rescue, “means that a large percentage [of AT1s] are priced to perpetuity rather than to their first call,” Miginiac says. “That creates potential for spreads to tighten as we face about €30bn-equivalent of calls in 2024”, when including non-euro currencies.

UniCredit expects subordinated spreads to move similarly to senior debt: unchanged at first and then tightening as the year progresses.

But not all foresee such a simple trajectory. “It’s tough to say where spreads of bank capital will be in 2024,” says Arnaud Mezrahi, group head of medium and long-term funding at Société Générale, speaking when the French bank restarted AT1 issuance, just before UBS’s deal in early November, with a $1.25bn trade.

“In the last two, three years, none of the market participants were right in their predictions,” he continues. “You have a funding programme to execute and there are workable days and windows at the right price, and you take them. AT1 and tier two spreads may tighten; I sure hope so, but it is too easy to manage a funding programme looking backwards.”

Still, there are supportive technical factors that apply to both AT1 and Tier two debt, Miginiac says. There will be less issuance, as most bonds are being refinanced at their first call dates. Adding that “one cannot perform without the other”, he sees “the best value is in AT1s, as they offer good convexity”, but he also sees “decent value” in investment grade tier twos, especially callable deals.

Survey respondents were most divided about the biggest risk facing issuers in 2024. The majority thought this was linked to deteriorating macroeconomic conditions, followed by those who chose the sovereign-bank doom loop, where one market’s problems could take the other into a recurring, vicious, downward spiral.

Miginiac says that “macro will be the biggest curve ball” for the FIG market as it will affect all capital markets. “Macro will be the key driver in the short-term direction for spreads across FIG asset classes,” he says, “even if we think the AT1s will perform well after showing a decade of track record.”

Either persistent inflation or a recession induced by excessive inflation controls are a threat. “Both of these cases will lead to headwinds for credit to perform,” Miginiac says, as he concludes that for subordinated debt spreads to perform, “they will depend on credit markets doing well.”

Meanwhile, as the ECB and the Fed decrease their balance sheets, Hoarau asks whether the market will be able to absorb “mountains of debt”, as FIG borrowers will have to fight for liquidity alongside SSA issuers.

“That’s a key question for the second half of the year when the liquidity-supply dynamic will be less favourable,” he continues. “So, issuers will again front-load heavy funding plans, fearing the market in failing to absorb the growing supply.”

This is why he thinks the biggest risk for markets in 2024 will be liquidity. “For the time being, excess liquidity prevails but nasty headlines around sovereign debt could very well be back on the agenda, pushing the global spread complex higher,” he says.

The ECB’s commitment to reducing excess liquidity in the system could be bad for small banks especially. These issuers will be facing their “eternal challenge” of how to capture investors’ attention and expand their buyer base at a time “when real money investors are not obliged to go down the credit curve to capture higher rates”, Hoarau says.

But there is hope, Hoarau believes, in the rate cutting cycle that, he says, is likely to start in Europe first. “This will definitely be the key support for the year,” he says.

Others see different major risks.

“The biggest known unknown for capital markets next year will be geopolitics — in particular, the US election,” says Lloyds’ Hughes. “However, while at the moment the markets seem to believe inflation is under control, it won’t take too many adverse data points for nervousness to re-emerge.”

Funding diversification will be one of the key themes that issuers are expected to focus on in 2024. Many market participants stress how the prohibitively expensive dollar market for much of the first half of 2023 meant that European banks were stuck funding in their home markets, which exacerbated spread widening.

“Currency diversification will be a prime objective for a growing number of issuers in 2024,” says Hoarau. “They will be more flexible when looking at the arbitrage situation. More banks will accept to pay up to diversify and accept negative arbitrages to remove pressure from the domestic market.”

Mezrahi highlights that when it comes to 2024 funding, Société Générale is open to all markets. “The euro is our core currency,” he says. “The dollar is super-important for us, while all other currencies are important too.”

He adds that the bank has “a strategy to be a more frequent and regular issuer in the sterling market, either from a pricing or from a diversification point of view”.