Macro challenges face FIG primary market boosted by rate cuts

Financial institutions raising unsecured debt had a phenomenal year in 2024, one characterised by almost constant spread tightening. However, next year is expected to be different.

The appetite for unsecured FIG debt is set to remain, but market participants who responded to GlobalCapital’s market outlook survey think credit spreads are likely to widen by the end of the year.

Contributing to the favourable market in 2024, according to Alberto Maria Villa, head of FIG syndicate at UniCredit, was the fact there were no substantial shocks of the variety that have dogged markets in previous years — such as the collapse of Silicon Valley Bank and Credit Suisse in 2023, for example.

Instead of “large and prolonged shocks”, there were smaller bouts of volatility — “blips, such as the European Union election aftermath or the August spike of volatility,” says Villa.

Meanwhile, the higher interest rates were a boon for bank earnings, which in turn provided a tailwind for their bond issuance. “Banks have taken credit for their strong earnings all the way from 2022 through 2023 and now this year,” says Isaac Alonso, head of debt capital markets for Germany, Austria and Switzerland at UniCredit. “They have robust balance sheets, reflected in their capital positions.”

However, as the European Central Bank continues to cut interest rates, that will drive expectations that eurozone banks’ net interest income will shrink.

One of the main changes expected in the primary market in 2025, according to survey respondents is for spreads to widen. Some 80% of the respondents think senior preferred spreads will finish 2025 wider than at the end of 2024, while 65% see that happening for non-preferred spreads.

By mid-November 2024, FIG credit spreads moved to such tight valuations that many market participants think some widening is inevitable. This is more likely, they say, if accompanied by economic weakness, particularly in Europe where growth has largely faltered.

“We have seen higher yields bring out buyers of credit as investors want to lock these rates in and this in turn has led spreads to tighter levels,” says Mark Geller, global head of FIG debt capital markets at Barclays. “But the flipside is that higher-for-longer rates and yields does tend to be a brake on the broader economy.”

Noteworthy in the survey is that a smaller number of respondents expect bank capital spreads to widen compared to senior bonds. About half the respondents expect this for additional tier one (AT1) spreads and 60% see this happening for tier two notes. However, unlike senior bonds where none thought that spreads would tighten, around 15% of respondents saw this as a possibility for AT1s and 20% for tier two spreads.

“Fundamentally, there is very strong appetite for subordinated debt [as] investors want to lock in yields with the prospect of further rate cuts on the horizon, which means demand dynamics for AT1, restricted tier one and tier two are good,” says Geller.

Yet, he also points out that with spreads, as of mid-November, “at recent historical tights for subordinated debt, some investors are becoming more selective on the deals they are willing to buy”.

However, not all foresee an immediate worsening in funding conditions just as the year turns. As 2024 draws to a close, there has been more demand for bonds than issuance, which is likely to lead to it being an issuer’s market for longer.

“In the very early part of 2025, the market will remain accommodative for senior unsecured and capital products as appetite will outmatch the prospective potential supply [that is mostly pre-funding] from [mid-November] to year-end,” says Villa.

He expects the new year to start with “a positive outlook for primary unsecured debt”, but “for the rest of the year, it’s harder to form a view because there are too many unknowns, but the base line is a constructive one”.

What the ECB does next with interest rates is expected to be probably the biggest theme of 2025 in the European FIG market. A full 65% of respondents think the biggest risks next year will be macroeconomic factors.

What the ECB does compared to the US Federal Reserve is of particular interest. “There is potential for divergence between the US, where the prospect of material rate cuts has been recently reduced, and Europe where there is more belief in sequential rate cuts expected over 2025,” says Geller.

“The ECB’s increasingly less restrictive monetary policy stance will be positive for credit,” agrees Matteo Benedetto, head of FIG syndicate at Morgan Stanley. “The market expects a supportive ECB ready to counter the impact from growth [in Europe], potentially coming from the US government’s fiscal plans, with rate cuts.”

This anticipation, he adds, will translate into a “very healthy set-up for 2025, not just for FIG but for credit overall”. He also highlights that there is plenty of liquidity in credit markets in Europe, meaning that “the view for 2025 is bullish for credit as long as macro is stable”.

“Inflation could gain in the US next year from the Trump administration’s proposed inflationary policies,” says Vincent Hoarau, head of FIG syndicate at Crédit Agricole. “In that consideration, the monetary policies of central banks will be closely followed as they could turn the sentiment in the FIG market.

“Another part of the central bank watching is how long will [Jerome] Powell stay as the Fed chair as this could influence markets too. Trump’s new economic measures may clash with the Fed’s inflation control efforts. The headline risk of tariffs and potential trade war with China will be another risk factor and markets will be watching to see if it will be like in 2016-2018.”

Geopolitical risk is another factor that could affect the FIG market. “It may be that some of the current conflicts could come to conclusions in 2025,” says Geller, “which would be market positive, but it is tough to argue that the risk of further escalation is currently priced by the market.”

“By far, the most supportive factor for tight credit spreads is the liquidity-carry combination,” says Hoarau. “As long as euro rates remain above the 2% mark, the bullish credit narrative should remain solid.”

UniCredit’s Villa points to the increasing likelihood that the ECB will stop cutting rates at a level below 2%. Even then, “this will still be within the cycle where positive net inflows are expected to continue into fixed income,” he says.

If such conditions prevail — even factoring in possible spread widening — 70% of survey respondents expect that lower tier banks will have no worse market access compared to this year. Only 20% think it will be more difficult and 10% expect them to have better access.

Senior and subordinated issuance volumes in euros are largely expected to remain similar to 2024, with 65% and 60% of survey respondents expecting the same volumes in the respective asset classes.

GlobalCapital’s Primary Market Monitor tracked more than €196bn of public senior FIG euro debt issued between January and the end of October 2024, including deals from central and eastern European institutions, and just under €65bn of subordinated paper. That compares with almost €201bn of senior and €40bn of subordinated issuance for the same period in 2023.

Marine Leleux, ING’s sector strategist for financials, sees the primary FIG market in 2025 being “active despite banks issuing a slightly lower amount of bonds than in 2024, with a total supply of €400bn,” including covered bonds.

ING says in a research report that “the higher redemptions level will be the main driver pushing new issuance levels upwards”. Covered bond redemptions will be €18bn higher in 2025 than they were in 2024, €33bn in both senior asset classes and €18bn more in tier two and AT1 debt, says the Dutch bank. It expects the €400bn of overall FIG supply it predicts will come in 2025 to be split into €155bn of secured issuance, €200bn of senior and €45bn of bank capital.

UniCredit’s Alonso expects issuance activity in 2025 to be concentrated on refinancing callable debt across the capital stack as the refinancing need will increase compared to 2024. “But that doesn’t mean there is a redemption wall as it will be all absorbable,” he stresses. “Investors want reinvestment opportunities.”

Respondents expect more mergers and acquisitions in the banking sector. In turn, this may push up issuance from selected banks.

“The 2025 unsecured supply will be higher only in very specific isolated cases where increased funding needs will be driven by M&A situations,” says Hoarau. “For most other major European banks, it will be a relatively stable situation.”

Around half of survey respondents expect that banks’ debt issuance will be tied to financing environmental, social and governance (ESG) initiatives — roughly the same as in 2024.

With €70bn-equivalent of ESG bank issuance globally since the start of 2024 to mid-November, ING says this year is the first in a decade that volumes were expected to be lower than the year before.

“Part of the reason [for the slower pace of issuance] is the stronger regulatory emphasis on green bonds, as outlined in the EU taxonomy regulation and the EU green bond standard,” says ING.

It expects around €70bn-equivalent of ESG issuance in 2025.

Survey respondents think the majority of banks’ unsecured issuance will be in senior format. Half voted in favour of non-preferred debt, followed by around 28% choosing senior preferred with covered bonds taking the balance.

The tightening of the Bund-swap spread in euros during 2024 sent the covered bond market into disarray by the time it turned negative in November. That created “a very strong contrast” between secured and unsecured markets, says Hoarau, who expects this will likely remain the case until the early part of 2025.

That spread tightening became a challenge for the covered bond market where bonds traded wider against swaps. Issuing such a deal turned from what has been “typically a matter of preference for issuers, [to] now being a matter of possibility as well,” points out Villa.

“With covered spreads of core issuers widening but senior preferred of core and Nordic issuers not moving, this suggests that the convenience of senior issuance for banks will increase,” says Benedetto.

The other topic to unite survey respondents in their views was that the sterling market will be the next most used by borrowers in 2025 after issuance in euros and dollars.

After strong capital issuance in 2024, concerns surrounding banks’ willingness — or in some cases ability — to redeem their most subordinated debt capital at the first instance may flare up again.

Some 40% of survey respondents expect no concerns surrounding AT1 extension risk. But the majority think some kind of problems may arise in 2025.

“The biggest question facing this segment is how more compressed and tighter capital can get,” says Benedetto. “At some stage the upside and downside scenarios will flag that spreads will be subject to some widening pressure and decompression.” He expects this to be “more of a development late in the first half of next year or early in the second half”.

However, many banks have opted to pre-empt their refinancing of such strategic capital well ahead of their call dates, with around $15bn-equivalent of AT1s issued between September 2024 until the end of October. That effectively brought forward some of the calls that were due in 2025.

“Some issuers have taken advantage of conducive markets — spreads at tights and investor demand high — to bring forward some of the refinancing of calls due in 2025,” says Geller. “The use of tenders to reduce the cost of carry has also been a feature of deals this year. Despite this, there are many calls across AT1 and tier two next year and in 2026, which should keep the supply going.”