Issuance increase in 2017, improvement in issuers’ financial health: sources see link

By Emma Trincal

New York, July 17 – One overlooked factor in this year’s spectacular growth of U.S. structured product issuance is the improvement of banks’ balance sheets and the resulting tighter credit default spreads, sources said.

Other factors such as the stock market rally and the multiplication of the number of deals through automation play their part.

But sources said not to underestimate the role of credit ratings in a financial adviser’s buying decisions. As credit has substantially improved, one reason to object to a deal has disappeared.

Stress tests

Volume for the first half of the year has grown by more than 45% to $23.3 billion, according to data compiled by Prospect News.

At the end of June, all 34 banks required by the Federal Reserve to go through stress tests passed. Last week, JPMorgan, Citigroup and Wells Fargo reported better-than-expected second-quarter earnings.

“The fact that all these banks passed the stress [tests] allowed them to pay huge dividends and buybacks. The fact that sometimes they returned to the shareholders up to 100% of their net income and that the Fed allowed them to do that proves that their balance sheet is very, very strong. That’s why their CDS spreads have tightened,” said Dick Bove, bank stock analyst at Rafferty Capital Markets.

Barclays

Tighter spreads are also visible in Europe as well.

Barclays’ CDS spreads narrowed to 44 basis points today from 115 bps a year ago, according to Markit.

While it’s impossible to draw the conclusion from raw data that tighter spreads push up sales, the numbers do not contradict sources’ assertions.

Barclays Bank plc, the No. 1 issuer in the first half of this year with $4 billion, has seen its volume skyrocket by 142% from $1.65 billion during the same time last year, the data showed

Deutsche Bank

Deutsche Bank AG, London Branch, an issuer that had disappeared from the market during the fourth quarter of last year, is now back with a much stronger credit profile.

The German bank exemplifies why credit is still important for investors and how a distressed name will have a hard time finding distribution.

Last fall, Deutsche Bank was fined $14 billion by the U.S. Justice Department regarding sales of residential mortgage backed-securities but ended up settling with the government for $7.2 billion.

The bank, which had gone through leadership turnover and incurred substantial losses since the financial crisis, was considered a “systemic risk” by the International Monetary Fund given its heavy presence in the global derivatives market.

Crisis

Plagued by rumors of becoming the next Lehman Brothers, Deutsche Bank stopped issuing structured notes at the end of September.

“People were worried about the long-term viability of the bank,” said a distributor.

Deutsche Bank is slowly recovering.

In the first nine months of 2016, Deutsche Bank’s volume was $658 million. In the first six months of this year, it has already issued $528 million.

Last November, the five-year CDS spread of this issuer reached 220 bps. It has now tightened to 79 bps, according to Markit.

“While tighter spreads don’t give the best funding rates, when headlines raise suspicions, investors go back to risk aversion mode,” a source said.

Wider spreads are acceptable and often sought after, if they provide better terms for a deal. But when it becomes alarming, a questionable issuer will have a hard time finding investors and distribution, a source said.

“Even though we believed that Deutsche Bank was too big to fail because the German government would bail them out, no question, we were still a little bit concerned,” said Steve Doucette, financial adviser at Proctor Financial, who had bought a number of structured notes issued by Deutsche Bank.

“We got good deals with them. But when their spreads hit 220, that type of widening of the spreads, that’s exactly what we saw with Lehman in 2007 when it went up to 280-300 bps. Now their CDS spreads are back in the range.”

Back in business

An industry source said that Deutsche Bank is making a comeback as an issuer because its credit and reputation have both improved.

“A lot of this has to do with fear. People were worried about the financials, the fundamentals of Deutsche Bank back then. It was a name a lot of distributors wouldn’t want to touch. It’s not so much their credit spreads,” this industry source said.

“They were running into so much trouble, the headlines were so negative, it was really hard for them to do much. Things have quieted down. People get less of a sense that it’s a problematic credit. It comes with the tightening, but it’s tighter because of that renewed confidence,” said this industry source.

In the beginning of this year, Deutsche Bank still encountered some difficulties in restoring its name.

“People at the big wirehouses recommended staying away from this issuer until toward the end of Q1 when they reported earnings. They’ve been able to show improved capitalization, they reduced the headcount, and it showed in their results for Q1.”

Deutsche Bank issued its largest deals this year so far in May, one for $45.67 million and the other for $33.16 million.

“Deutsche reminded too many people of the Lehman situation whether it was deserved or not,” said a market participant.

“At the time, UBS kept selling the Lehman paper and had tons of settlement on them because of that, so people got scared about Deutsche. They started to pull back.

“But it created other opportunities for issuers selling against them and scaring away their clients.

“They’re stable now. With the implicit government backing, spreads have been tightening.”

Canadian push

By far the new “opportunists” are Canadian issuers. Their credit ratings and their less common names are attractive to investors who try to both reduce credit risk exposure and diversify their portfolio with new credit.

Bank of Nova Scotia has been the fastest-growing among the pack with $850 million through June 30, a more than three-fold growth from $240 million last year, according to the data.

Canadian Imperial Bank of Commerce has also increased its notional to $740 million from $580 million, a 27.6% growth. Bank of Montreal’s volume jumped 80% to $520 million from $290 million.

Finally Royal Bank of Canada, the only Canadian issuer to be in the top 10 league tables, has seen its volume climb 65% to $1.01 billion from $610 million.

Goldman Sachs, Morgan Stanley

In the United States, some of the weaker credits have also recovered, and volume for them is up too.

GS Finance Corp., the issuing arm of Goldman Sachs, saw its sales rise by more than 50% during the first half of this year to $2.84 billion from $1.88 billion during the same time last year. Goldman had spreads wider than 100 bps last year. They have now narrowed to 68 bps.

Comparison with Morgan Stanley Finance LLC, Morgan Stanley’s issuing subsidiary, is less direct. This issuer started at the end of March of last year. In the second quarter of 2016, it priced $340 million. But the growth trend is clear: in this year’s first half, Morgan Stanley Finance has already priced $2.24 billion. In other words, it has done in six months more than 6.5 times what it did in three months last year.

Morgan Stanley’s spreads were around 100 bps last October. They have stabilized at 63 bps today.

Advisers, especially those catering to retirees and conservative investors, say that while terms may not be as enticing, they prefer to see banks with sound credit.

“Credit is on the top of our list when selecting a note,” said Michael Kalscheur, financial adviser at Castle Wealth Advisors.

“I don’t know about other advisers, but I sure hope they are paying attention. That’s a key factor in the whole game.

“You don’t want to be taking risks you weren’t expecting. That’s how you get in trouble. I don’t want to get caught in something like another Lehman. I keep a close eye on credit.”

© 2015 Prospect News.
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