The eurozone banking sector has been force-fed cheap finance by Mario Draghi, president of the European Central Bank, since the eurozone crisis. Last week, banks digested barely half the 400bn euros in cheap four-year loans on offer from the ECB, presaging a gloomy outlook for issuance of bank bonds in 2015.
“Banks don’t need [the funds] — if they did they would be taking more,” says a London-based debt capital markets banker. “The debate goes on as to what are the reasons for the low levels of demand. On the one hand, there isn’t the client demand for loans, and on the other, there isn’t the credit appetite [among banks].”
Lenders are more concerned about paying back ECB loans than increasing their war chests for business lending. They have just borrowed a total of 212bn euros under the ECB’s latest liquidity injection aimed at boosting business lending, but will pay back 245bn euros in earlier loans in the first few months of next year.
Bank funding costs, according to the iTraxx financial index — which measures the cost of insuring bank bonds — have fallen more than a third since January. But analysts still predict that banks will redeem more senior bonds, a funding staple, than they sell next year.
“We saw a contraction in net negative issuance of senior bonds this year to 65bn euros from about 120bn euros the year before,” says Joe Faith, a credit strategist at Citi.
Institutions are more concerned with paying back ECB loans than increasing war chests for business lending
Following a lacklustre 2013, financial institutions have enjoyed a relatively bumper year for bond issuance. Overall debt issuance increased 29pc to $586bn in 2014, the most since 2010, according to Dealogic. That was buoyed by a 22pc increase in senior debt to $449bn and a 58pc increase in subordinated issuance to $136bn.
The latter total is the highest since the financial crisis, with sales driven by the need to boost capital ratios and build loss-absorbing buffers ahead of the ECB bank stress tests in October.
Although only a handful of institutions failed the tests, a widely predicted issuance glut has not been forthcoming. “It’s not about funding volumes; it’s about what kind of funding banks need,” says Armin Peter, head of European debt syndicate at UBS.
“Subordinated debt volumes will continue to grow at the expense of senior [debt volumes], driven by a continued reshaping of the capital base, lower economic growth and the need for bigger buffers.”
One beneficiary of regulation is the contingent convertible (coco) market. Banks are allowed to issue cocos equivalent to 1.5pc of their tier one capital under Basel III rules. Issuance this year reached a record 37bn euros, according to Citi, which expects sales of up to 40bn euros next year.
Another encouraging sign is the fact that eurozone banks have eased up on deleveraging, after more than two years of cutting their balance sheets back from heights reached in mid-2012. In September, the region’s banks increased their total assets by 100bn euros, while loans to non-financial corporates rose a modest 3bn euros, according to ECB figures.
But, amid low economic growth and the spectre of deflation, this increase in assets does not mean that deleveraging has stabilised. “Prices have stabilised but banks are still looking to let go of their asset pools which are non-core,” says Cecile Hillary, co-head of European financials’ debt capital markets at Morgan Stanley. “We don’t expect to see a huge increase in bank funding.”
The big uncertainty is to what extent second-tier eurozone peripheral banks will issue. Peripheral issuance overall increased 37pc to $86bn this year, against a core eurozone increase of 21pc to $264bn. Most of the increase was in the first half, dominated by so-called national champion institutions, perceived as bigger and safer.
Spain’s Banco Popular remains the only smaller peripheral bank to have issued a coco bond, widely seen as a litmus test for investors’ risk appetite. A second such deal has been deferred since the summer when Portugal’s Banco Espírito Santo was forced to restructure.
Broader peripheral issuance depends on the ECB’s prospective quantitative easing programme. Weaker banks could expect to benefit most from any large-scale sovereign bond buying, which would bolster investors’ hunt for yield and drive down funding costs.
“[Peripheral] volumes hinge on QE,” says Mr Faith. “If it happens, then mid-tier banks will issue sooner rather than later.”