European Bank Debt-Guarantee Proposals May Struggle to Thaw Funding Market
European banks, which need to refinance more than $1 trillion of debt next year, may struggle to fund themselves until policy makers follow through on a pledge to guarantee their bond sales.
European Union leaders promised this week to “urgently” look at ways to guarantee bank debt in a bid to thaw funding markets frozen by the sovereign debt crisis. Lenders have found it hard to sell bonds for the past two years and have increasingly turned to the European Central Bank for unlimited short-term emergency financing.
“The biggest problem at the moment is that banks haven’t been able to fund themselves,” said David Moss, who helps manage about 8.5 billion euros ($12 billion) at F&C Asset Management Plc in London. “If banks can’t fund themselves, they’ll struggle to exist.”
In 2008, the U.S. Federal Deposit Insurance Corp. gave a guarantee on bank bonds, allowing financial institutions to access markets with the backing of the government. For European policy makers to replicate the success of that program any warranty would have to be given at the EU level because the deteriorating public finances of southern states means they would struggle to back their banks, analysts said.
“It’s a valiant attempt to get term funding kick-started again,” said Andrew Stimpson, an analyst at Keefe Bruyette & Woods Inc. in London. “But investors’ concerns are with the sovereigns not the banks, so putting the onus on the sovereigns to guarantee bank issuance does not sound convincing.”
Concern that banks will have to write down their holdings of peripheral sovereign debt has sent bank stocks down 24 percent this year, according to the Bloomberg Europe Banks and Financial Services Index.
Bank stocks rose for a second day today after EU leaders agreed to bolster lenders’ capital, boost the size of the region’s rescue fund and persuaded bondholders to accept a 50 percent loss on their holdings of Greek debt. Yet a gauge of banks’ willingness to lend to each other widened to its most in more than two years yesterday, showing strains in the money markets didn’t ease after the announcement.
The spread between three month dollar Libor and the overnight indexed swap rate -- a barometer for dollar-based bank-to-bank lending markets -- yesterday widened to 34.3 basis points, the most since July 2009.
A co-ordinated approach at the EU level is needed to support banks’ access to the funding markets, the European Banking Authority said in a statement.
“The EBA has been asked to work with the EU Commission, the ECB and European Investment Bank to urgently explore options for achieving this objective,” said the group, which oversees the work of regulators in Europe.
Analysts questioned whether the European Financial Stability Facility, which policy makers said would be leveraged to 1 trillion euros, is big enough to take on responsibility for underwriting bank debt.
The European Investment Bank, which is funded by member states including those outside the single currency, today ruled out providing “any kind” of financial support to the bank debt plan, according to an e-mail.
No European Guarantee?
Under plans being considered by policy makers, Europe would only co-ordinate the guarantees rather than provide them, according to a person with knowledge of the matter. The proposal would also be unlikely to require approval by all member states, said the person, who declined to be identified because the talks are private.
“There is talk about Europe-wide bank guarantees, but it is not clear yet how that would work,” Alberto Gallo, head of European credit strategy at Royal Bank of Scotland Group Plc, said in a telephone interview. “What is clear is that the EFSF doesn’t have enough fire-power to support this -- as well as standing behind the sovereigns and any bank recapitalizations.”
European banks were unable to sell senior unsecured bonds for more than two months this summer, the longest period on record without an offering. Deutsche Bank AG (DBK) ended the drought on Sept. 29 with a 1.5 billion-euro offering. The lender priced the notes at a yield of 98 basis points more than the three- month euro interbank offered rate, according to data compiled by Bloomberg. The same lender paid a spread of 40 basis points to issue two-year securities in February.
Europe’s banks need to refinance about 800 billion euros of bonds over the coming year, according to Gallo. Most banks typically try to meet some of that funding need months before they require it, a process known as pre-funding.
“Only a small proportion has been pre-funded given that the markets have been virtually closed since July,” Simon Adamson, a London-based analyst at independent research firm CreditSights Inc. said in an Oct. 25 interview.
In all, Western European lenders raised about 80 billion euros of senior unsecured debt denominated in the single currency this year, according to data compiled by Bloomberg. That’s 20 percent less than the 100 billion euros they raised in the same period in 2010.
Some of the slack will be taken up by covered bonds, Gallo said, which are considered safer by investors because they are backed by assets such as mortgages or loans. Banks globally have sold a record 318.1 billion euros of covered bonds, up from 310.1 billion euros in the same period in 2010, Bloomberg data show. The ECB said this month it would buy as much as 40 billion euros of covered bonds from November 2011 to October 2012.
The extra yield investors demand to hold banks’ senior bonds instead of benchmark government debt soared to a record 360 basis points on Oct. 4, according to Barclays Capital’s Euro Aggregate Banking Senior Index. The spread has since narrowed to 315 basis points, still almost double its average of 178 basis points for the past four years.
Banks that have been unable to tap the bond markets are likely to become more reliant on the ECB for funding. When the Frankfurt-based central bank revived a tool last used at the end of 2009 to ease money-market tensions on Oct. 26, 181 banks borrowed a total of 56.9 billion euros for 12 months. The identities of the borrowers weren’t disclosed.
European governments including France, Spain, the U.K. and Germany guaranteed some bonds issued by their banks to reassure investors after the collapse of Lehman Brothers Holdings Inc. in September 2008. In May 2010, the EU ended the program when it said banks that relied on the pledges would face a review of their long-term viability.
In the U.S., the Temporary Liquidity Guarantee Program allowed banks to issue bonds with backing from the FDIC for as long as three years. Borrowers paid a fee of 0.5 percent to guarantee debt due in six months or less, 0.75 percent for debt going out one year, or 1 percent for longer-dated maturities, according to terms on the agency’s website. More than 85 percent of U.S. banks participated in the program, including JPMorgan Chase & Co.
About 66 banks had issued $231 billion of FDIC-guaranteed debt as of Aug. 31, according to the FDIC. Sheila Bair, the agency’s former chairman, told Congress in November 2008 that in the month following introduction of the program, “we have seen bank funding rates moderate significantly.”
For the European guarantee to work, it would need to be provided by a pan-European body such as the European Investment Bank, said Philippe Bodereau, head of credit research at Pacific Investment Management Co.
“If guarantees are provided on a pan-European basis, that would be very positive but the track record for these things is that they take time,’” Bodereau said. “This could be the most important aspect of the plan for the banks.”