TwentyFour Blog

The cycle of banks calling outstanding capital bonds continued this week and we’ll soon be bidding fond farewells to two of our long held and favourite positions; Nationwide’s 6.875% Additional Tier 1 (CoCo) and Barclays’ 14% hybrid Tier 1.

The Bank of England’s credit conditions survey for the first quarter of 2019 was released last Thursday, coinciding with an extended holiday period for many commentators, but certain sections made for interesting reading and are worth highlighting.

The end of 2018 and beginning of this year has been a tough time for credit, but it has also created an opportunity for CLO managers to invest in good companies at cheaper prices.

They have been dating for some time, and been the topic of discussion at numerous dinner parties, even its good friend Covered Bond got hitched, but now RMBS has taken the plunge and tied the knot with Sonia (the Sterling Overnight Index Average), having finally ditched long-term previous partner, Libor.

Since the start of the year credit markets have been very well supported, reversing much of the sharp period of spread widening we experienced in the final quarter of 2018.

The ECB published the result of its Supervisory Review and Evaluation Process (SREP) yesterday, which increased the average capital requirements for European banks, and overall, increased the average SREP requirement by approx. 100bps.

Deoleo is a Spanish olive oil company that people will know from its brands like Bertolli. It’s long been considered to be one of the “idiosyncratic” stories in the European leverage loan market. The deal has an 85m revolver, a 55m second lien tranche and widely traded 460m senior secured tranche.

One of the challenges that banks face when considering the re-financing of AT1 capital is market timing. Treasurers have to answer the question whether to issue when market conditions are supportive, which may result in a considerable period when they have two overlapping securities (adding to their interest overhead); or wait to refinance just before the call date, which of course increases the risk of having to issue in a market demanding more punitive terms.

The period following the full year results releases from the banks is typically followed by large volumes of subordinated bond supply from the banks. This year is no exception as the pace of new issues is ramping up, in particular in the higher beta Additional Tier 1 (AT1) securities; colloquially known as Coco bonds. Already this week there have been new benchmark issues from BBVA, Barclays and BNP, taking 2019 issuance to date in this sector to a total of €14 bn.

he first quarter of 2019 is coming to an end and after a bumpy end to 2018 we did not expect to see a lot of issuance of new CLOs once the pipeline had cleared. But although CLO debt remains expensive for equity investors (arbitrage has only gotten worse as the leverage loan supply is still slow) there seems to be no end to new deals coming to the market. There are a few things that for us as debt investors stood out; the strong Japanese bid for AAAs, structural differences, varied pricing and spreads that have not recovered as quickly as for similarly rated corporate bonds.

The big monetary policy event over the month was the increase of monetary stimulus announced by the ECB after two years of slowly weaning the Eurozone off extremely easy money. At the ECB meeting of Thursday the 7th of March Mario Draghi announced the introduction of new TLTRO (the last round ended in December 2018, so this is TLTRO III) and interest rates guidance was modified for the current levels to remain to the end of 2019 (previously mid 2019). Market consensus is for an even longer pause.

One of the elements we look at on our dashboard that guides us on the state of the economic cycle is credit rating migration. We look at spread movements too, but rating change gives us another line into the risk that rated entities are taking or are confronted with. While we recognise that rating change is a backward looking indicator, viewed in conjunction with other measures, it is possible to draw some important conclusions.