LONDON, Jan 27 (IFR) - Any remaining fears that financial institutions would not be able to fund themselves in the public market were dispelled this week, when Lloyds and Swedbank attracted some of the largest order books for bank paper in 2012, as spreads rallied on the back of short covering.
While senior issuance has been good so far this year, appetite for this week's deals was much stronger than for the trades priced in early January, allowing issuers to price transactions much tighter than initially thought and leading to a strong after-market performance.
Yet while the supply/demand dynamic should play out in favour of borrowers, market participants remain wary of any potential reversal in tone.
"Once you get sentiment going one way, there is a tendency for people to ignore the bad news and there is a tendency for momentum to take over," said a head of FIG DCM.
"It's clear that there is a strong positive feedback loop right now, and you can definitely feel the shot in the arm the ECB LTRO has given to the market. We expect it to last until the second LTRO, and the question is whether it keeps going after that."
Another head of EMEA FIG echoed this view.
"There is no denying that the LTRO has a positive effect, especially in the sovereign market, where it has given a strong technical bid to peripheral sovereigns at the short end and steepened the banks' curve, as well as taken out a huge amount of potential supply," he said.
"This, added to the technical bid that you would normally get at the beginning of the year, because investors have got so much cash to be put to work, has contributed to a positive market tone."
He said it was premature to say whether LTRO would avoid a credit crunch: "From the conversations we are having, banks are using the LTRO to cover their redemptions and not necessarily increase lending to the economy."
For now, however, there is no denying that the rally has been strong, driving spreads tighter, even for peripheral banks. For example, some of Intesa San Paolo's bonds are over 150bp tighter since January 9, while UniCredit (MDD: UCG.MDD - news) 's cash curve has also performed well, tightening by over 160bp over the same period.
French banks have also seen strong performance, with BNP (Paris: FR0000131104 - news) Paribas and Societe Generale (Paris: FR0000130809 - news) tightening by more than 50bp-60bp. Some of the most recent new issues, such as a five-year for ING, have tightened by more than 80bp.
The same can be said of the indices. Since January 9, the senior Itraxx has tightened by 84bp to 211bp, while the subordinated index has tightened by 160bp to 366bp. And many believe it will continue.
"We think the rally still has legs, though, even after a record January move. Banks were a consensus underweight by credit investors at the end of last year," said Bank of America (NYSE: IKJ - news) Merrill Lynch (NYSE: MER - news) analysts in a note this week. "The ECB has now made this a painful one. We think investors will continue to cover shorts, adding more weight to the rally."
Investors echoed this view.
"The supply outlook for this year was already benign, given that banks are shrinking their balance sheets and even a 1% reduction in assets will have a huge impact on redemptions," said a fixed income investor this week. "This, added to the LTRO, makes the outlook brighter for banks, at least for now."
PERFECT TIMING
Lloyds TSB Bank and Swedbank were the only two borrowers to take advantage of the rally this week, although more are expected to follow as soon as they come out of their blackout period.
According to bankers on the deals, the cost benefit from waiting had been in the region of 100bp for Lloyds and 50bp for Swedbank. They attracted a combined EUR7.5bn of orders for their deals, some of the largest books seen for financials this year.
"There is a lot of LTRO money floating around and, while it might not be going straight into the deals, it is making investors more confident about things. The fact that they know that banks have got access to ample liquidity is clearly helping the tone," said a syndicate on the EUR1.5bn five-year Lloyds trade.
Both issuers were able to price their transactions tighter than initially thought. In the case of Lloyds, it priced at 305bp over, 10bp tighter than initial price thoughts. Meanwhile, Swedbank priced at 183bp, 7bp tighter than initial guidance.
Both trades tightened by 15bp post pricing.
"It is fantastic to see the breadth of demand for the deals," said a FIG syndicate banker. "Some investors who had been staying on the sidelines until now are now getting involved."
GO NOW
Bankers are urging clients to take advantage of the strong tone and not just rely on the ECB for funding. "The more cautious issuers will continue to issue, extend their curves and won't just rely on the ECB," said the head of EMEA FIG DCM. "They need to make sure they keep their curve alive and have a smooth refinancing profile. Also, banks should try and avoid having a huge refinancing cliff in three years time."
A head of FIG syndicate echoed this view. "While the stigma of going to the ECB has clearly gone away, as an institution you can't have a business model solely funding by your central bank," he said. "That's not something you can sell to equity accounts." (Reporting by Helene Durand, Editing by Marc Carnagie)
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