'Risk-loving' FIG investors unfazed by PBB volatility

Investors were happy to take on FIG risk this week and displayed strong appetite for European bank bonds across the capital structure, even after S&P downgraded Deutsche Pfandbriefbank (PBB) on Wednesday evening.

“The market’s concerns have been very much confined to the banks with large US commercial real estate (CRE) exposure,” said one banker on Thursday, “That is why PBB and Aareal have suffered the most in terms of spread widening.”

In the unsecured market, RBI, which had attracted a lot of scrutiny due to its previously large operations in Russia, amassed a subscription ratio of 7.2 on Thursday despite tight pricing on its no-grow €500m 5.5 year non-call 4.5 senior non-preferred.

Also on Thursday, BPCE underlined that investors have ample appetite for bank capital as the French issuer priced a €500m social tier two, which was more than 11 times subscribed.

In covered bonds, Banco BPI’s final order book of €2.85bn for its six year offering demonstrated that “the market is still risk-loving”, according to a banker away from the syndicate.

But one area of the primary market that was not tested this week — either in covered or unsecured bonds — was that for German issuers.

In covered bonds, the most recent transaction from a German bank was LBBW’s €500m 10 year on February 7 which garnered “quite modest” orders of €1.25bn and led rival bankers to say it was “definitely driven” by US-fuelled concerns rippling into German Pfandbriefe.

But other bankers speaking this week were less concerned about prospects for the Pfandbrief market. Firstly, they pointed out that the absence of German issuance had been due to the fact there were fewer German market participants at work given the Carnival celebrations in the company.

Secondly, analysts have highlighted that German Pfandbriefe offer greater investor protection than any other covered bond regime, so despite their heavy exposure to commercial real estate, where prices have fallen the most, the bonds are unlikely to suffer.

“We are confident about German covered bonds because of their overcollateralisation and valuations” said one banker on Thursday, “Plus they also have the systemic support from the German government — you must not forget that.”

Even for banks such as PBB and Aareal, which have higher US real estate exposure, analysts have highlighted key aspects of their funding that are likely to promote resilience in the near-term.

For instance, Joost Beaumont, head of bank research at ABN Amro, told GlobalCapital that they tend to be less reliant on overnight deposits for funding.

“For the US and Swiss banks, it was a run on deposits that triggered their crisis [in 2023] and was more of a liquidity issue than a solvency issue. But a bank such as Aareal is more reliant on the wholesale market for funding. Normally, you might say that is a not good thing, but in this case it makes them less vulnerable to bank runs.”

Looking ahead, Beaumont is optimistic about the outlook for the European banking sector. “In general, investors still have a lot of confidence in banks,” he said. “They have high capital ratios and their non-performing loan ratios are relatively low. Plus, the higher interest rate environment led to record profits in 2023 and, while that might be less in 2024, we are not going back to the same lower levels as a few years ago.”

Meanwhile, shaky macroeconomic conditions — such as the UK GDP data showing on Thursday that the country had entered a recession — may have prompted some market participants to think that these would also translate to the FIG market.

But there was no sign of that by Thursday. To the contrary, the market had improved after the initial response to the higher US inflation on Tuesday that pushed rates higher.

“The market isn’t 100% in sync with the economic numbers and the headlines but we are seeing no constraints for new deals,” said one DCM banker involved with new issuance on Thursday.

After the US CPI-induced spike in rates on Tuesday, they fell on Wednesday and Thursday as the view that major central banks will cut rates sooner than later prevailed once again.

“The cuts will come, just not as early as we expected, but then again investors knew that and weren’t buying the March cuts narrative, despite [earlier] valuations having shown these were priced in,” said another senior DCM banker. “There have been solid inflows and you have to put this money somewhere.”

“Everything is getting a big book today,” affirmed one FIG syndicate manager away from the new issuance. “People are buying blindly. They are chasing risk.” He added that “a lot of cash in the fixed income sector is searching for ways to be put to work”.

Given the FIG market remains in such a healthy condition, some bankers have been left scratching their heads when asked what could derail the market.

“There’s nothing obvious,” said one. “I suppose if the situation in US commercial real estate really deteriorates and we end up with a ghost town in New York, but that is an extreme outcome.”

Another banker suggested the most likely challenge would be indigestion of supply, probably in the longer end of the curve.

“Perhaps in lengthier maturities of the covered bond curve the outlook is not as strong as it was a few weeks ago,” he said, “The last 10 year was from LBBW and that didn’t have a great order book, but it’s hard to know if that was because of CRE worries or the fact it was the second time in the market this year.”

Elsewhere, BPCE’s €750m 12y tranche on February 8 drew €1.6bn of orders and failed to replicate the success of Société Générale a few weeks earlier. “It was good, but not amazing,” said a banker away from the deal.

“Possibly we will see the market reach an equilibrium point and it will slow down, most likely in the longer-end which could start to feel a bit heavier,” he said. “But we are definitely not at that point yet.”