Return to Tenders

This week markets in general have taken a pause to catch their breath - not only from the rally from New Year, but also to digest news flow from the ECOFIN meetings and the Davos summit.  The bulls and the bears will be closely following the latest developments in the Greek PSI talks as a guide for where the market will go next. Talks seem to be progressing well (albeit predictably slowly) and now the ECB has been dragged into the equation. Should they too take losses on their €40bn holdings to help fill the gap? This will no doubt be high on the agenda at Monday’s upcoming EU summit in Brussels, along with whether the EU will be willing to support the PSI by considering the terms of the €130bn bail-out package.

While things hang in the balance on these talks, it is worth noting that banks have returned to the tender trail; this week we have had tenders announced from Unicredito and Credit Agricole. In total this results in another €5.1bn of subordinated securities that will be leaving the market. On average the premiums offered by the banks were around 10 points above the preceding day’s secondary market price.

Just to recap, for those that have not heard this before, the rationale for banks to buy back this debt is very clear and very persuasive: by buying back existing debt below par they lock in a gain that goes straight through to their core tier 1, a ratio which is being forced by EBA rules up to a minimum of 9% by June 30th this year. The securities that the banks are targeting are, perhaps not surprisingly, those which have the greatest discount to par and will not count towards other capital under the new Basel 3 rules due to commence from January next year.

The trend of tenders and buybacks is likely to continue during the time that securities are at attractive discounts for the banks. For once, this is not only very good for bond holders but also good for shareholders as this is the lowest risk value creation they are likely to see in the coming years.

With very few bonds outstanding that will qualify for tier 1 capital under Basel 3 and the regulators almost complete lack of focus on Tier 2, the subordinated bond market as it stands is rapidly shrinking, providing a very strong technical backdrop for investors.  Hence it remains one of our favoured sectors, but on a very specific name by name and bond by bond basis.