European banks become darlings of US bond market

By Danielle Robinson

NEW YORK, Oct (KOSDAQ: 039200.KQ - news) 18 (IFR) - European banks, once shunned by conservative fixed-income investors, have suddenly become one of the hottest items in the US bond market, and especially their riskier subordinated debt, as France's BPCE discovered this week.

BPCE was swamped by more than US$6.5 billion of demand for a US$1.5 billion 5.7% offering of subordinated Tier 2 capital, enabling it to price at least 10bp cheaper than what it would have paid if the deal had been done at home in euros.

It had been waiting to see what impact the US government shutdown would have on Yankee bond spreads before jumping into the US market.

What it witnessed was huge spread-tightening in the past fortnight, as the shutdown unwittingly left investors thinking the Federal Reserve's tapering was more of a 2014 than a 2013 affair.

"We've seen a strong rally in higher beta debt and especially European subordinated bank debt," said David Knutson, senior FIG strategist at Legal & General Investment Management in the US.

"People are more desperate for returns now that tapering appears to have been pushed further out, and besides that, Europe seems much healthier."

TIPPING SCALES

Most US subordinated debt secondary levels were 10bp-15bp tighter on the week, and in Morgan Stanley (Xetra: 885836 - news) 's case, 17bp better.

But the rally in European dollar subordinated debt was double that.

ING's recent US$2 billion 10-year subordinated offering has ratcheted in more than 40bp since pricing at 300bp over Treasuries on September 16, and more than 22bp to 258bp on Friday, from 280bp just before BPCE priced its deal on Tuesday.

Much to the delight of underwriters in the US, the rally has tipped the scales in favor of the US bond market versus euros, at least when it comes to European banks issuing subordinated debt.

"The US dollar market for subordinated debt is far and away better for European banks than the euro market," said a FIG debt capital markets banker at a US bank.

BPCE saved about 10bp by coming to the US dollar market rather than in euros, said sources close to the issuer.

Some FIG bankers said Rabobank and Royal Bank of Scotland (LSE: RBS.L - news) could pick up at least 50bp by issuing subordinated debt in dollars rather than euros.

"Although the basis swap isn't as attractive in the senior unsecured dollar market any more, it continues to be very attractive in subordinated," the coverage banker said.

QUALITY CONTROL

One London-based FIG banker said the benefits of financing in dollars versus euros for Tier 2 capital very much depended on the quality of the issuer.

Blue-chip European names like HSBC (LSE: HSBA.L - news) and Norway's DNB would probably achieve lower financing costs in euros, the London banker said, where they could also sell Tier 2 debt in the more efficient 10-year non-call five-year structure.

BPCE, led by active bookrunners Citigroup (NYSE: C - news) , Deutsche Bank (LSE: 0H7D.L - news) , Goldman Sachs (NYSE: GS-PB - news) , JP Morgan (Other OTC: JPYYL - news) and Natixis (Paris: FR0000120685 - news) , chose a similar execution game plan as ING in September, by starting out with initial price thoughts in the low to mid 300bp range - 337.5bp in BPCE's case.

That was quickly refined to initial price guidance of Treasuries plus 312.5bp (+/-12.5bp) as books swelled to almost US$7 billion. It finally launched at 300bp, a spread that offered a 20bp pick-up to the 280bp level the ING deal was trading at the time.

By the time Friday rolled around, investors' thirst for the bonds had pushed BPCE's subordinated debt spread down to 280bp in the secondary market.

Pricing was built by looking at Credit Agricole and Societe Generale (Paris: FR0000130809 - news) 's five-year senior unsecured Yankee bond issues from late September, which have also tightened in from respective Treasuries plus 130bp and 125bp launch spreads to around 115bp-120bp on Friday.

That gave BPCE a pricing reference of an implied new five-year senior issue at around the 135bp area. From there, 50bp was added for the credit curve difference between five and 10-year senior French bonds, to bring a new 10-year senior offering by BPCE to around Treasuries plus 185bp.

The leads then added 150bp of senior/subordinated premium, which brought them to BPCE 10-year Tier 2 initial price thoughts of around 337.5bp.

By the time it priced at 300bp, BPCE's implied senior/subordinated premium had been tightened in to 112.5bp-115bp, in line with the 110bp senior/sub premium for ING.