Draghi Breathes Life Into CoCo Market With Bank-Funding Move

Updated on
  • ECB to start paying lenders to borrow from financing facility
  • Riskiest UniCredit, Deutsche Bank notes rise after 2016 drops

Mario Draghi has come to the aid of bank-debt investors.

The riskiest type of bank bonds rose after the European Central Bank said it will start paying lenders to borrow from a four-year funding program. Notes issued by Intesa Sanpaolo SA and UniCredit SpA, the biggest users of the facility, were among the gainers. Deutsche Bank AG bonds, which have spearheaded a bank-debt rout this year, also advanced.

The funding changes could help banks’ earnings weather negative rates imposed by the ECB in a bid to bolster economic growth. Credit risk also eased across Europe after the central bank expanded a bond-buying program by a third and announced plans to start purchasing investment-grade non-bank corporate debt.

The bank-financing move “provides funding certainty at an attractive price in an environment of increasing volatility, and also an environment of large upcoming bank-bond redemptions,” Draghi said on Thursday.

Charges for using the ECB’s targeted longer-term refinancing operations, or TLTRO, will fall to as low as minus 0.4 percent, the new rate on the central bank’s deposit facility.

Bank-Debt Rout

The bond-price gains are rare good news in the $102 billion market for so-called additional Tier 1 notes, which has slumped this year on concerns about bank capital levels. Lenders can be barred from paying coupons on the bonds if capital drops too low.

The European Commission also separately told European lawmakers that holders of the notes may deserve “particular protection” from restrictions on payouts because they can’t be compensated when the issuer returns to profit.

The main risk for banks stemming from the ECB announcements is a further squeeze on the difference between what they charge borrowers and pay depositors. This key profit driver has been distorted by negative interest rates, and executives at lenders including UBS Group AG, Deutsche Bank and ABN Amro Group NV have said that further easing could undermine the industry’s business model.

“The squeeze on banks is definitely on and lowering the deposit rate adds pressure,” said Neil McCabe, a portfolio manager at Fiera Capital Corp. in Toronto, which manages more than $100 billion. “They’re starting to hit a wall when you think they probably can’t take retail deposits negative. It’s on investors’ minds and could weigh on bank spreads.”

Italian banks have been among the biggest users of the TLTRO facility, with Intesa Sanpaolo having drawn 27.6 billion euros and UniCredit drawing 18 billion euros, according to data compiled by Bloomberg. The program was set up in 2011 to encourage lending to the real economy.

The TLTRO changes “will bring funding relief to mid-sized euro-zone banks,” said Bloomberg Intelligence analyst Jonathan Tyce.

UniCredit’s 1 billion euros of 6.75 percent additional Tier 1 notes rose 4 cents on the euro to 83 cents, the highest in about a month, according to data compiled by Bloomberg. Deutsche Bank’s 1.75 billion euros of 6 percent bonds rose 2 cents to 82 cents.

The cost of insuring European lenders’ senior debt against default tumbled the most since October 2011. The Markit iTraxx Europe Senior Financial Index of credit-default swaps dropped as much as 14 basis points to 85 basis points.

(Updates with investor comment in seventh paragraph.)
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