January 15, 2013 5:21 pm

Investors rediscover eurozone bank bonds

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Flags of the EU member states fly in front of the European Parliament in Brussels

Fortune favours the brave and at present eurozone banks are the beneficiary of such daring by US-based investors.

In the rush for high returns, some US investors are snapping up the new debt issues of eurozone banks, returning to a sector they have shunned for the past few years amid the region’s debt crisis.

Even US investors who have yet to expand their portfolios into eurozone bank bonds now seriously consider such a move, attracted by the substantially higher yields on offer versus those of US peers.

Beyond the hunt for income in a low-yield environment, there is increasing confidence among investors that the European Central Bank’s “whatever it takes” resolve to shore up the eurozone will succeed.

“The world has changed in the past six months. It’s less risky,’’ says Sabur Moini, a high-yield bond portfolio manager at Payden & Rygel, who is now considering buying eurozone bank bonds after eschewing such securities almost completely in 2010 and 2011.

“If you think about Europe, the ECB managed to avoid a systemic collapse, the euro’s been rallying and with spreads on investment grade debt in the US so tight, I’m beginning to think holding some of those [European] bank bonds makes sense,” says Mr Moini.

The sharp drop in sovereign benchmark yields for countries such as Spain and Italy in the past few months appears to have finally opened the door for eurozone banks to tap the US market. Meanwhile, the improved outlook for the US and Chinese economies also spurs investors to move into riskier assets.

European banks have duly taken notice of US investors’ renewed interest and the banks, together with other global financial institutions, have been among the most aggressive group of borrowers in the US at the start of the year, with combined debt offers of $15.3bn, according to data tracker Dealogic.

In the largest dollar-denominated bond offering by a European bank to date this year, Italy’s Intesa Sanpaolo last week sold $3.5bn in three and five-year Yankee bonds. The offering was three times subscribed, according to Goldman Sachs, which co-led the bond sale.

“US investors are feeling more comfortable with bank bonds issued by eurozone peripheral countries,” says Jonathan Fine, head of investment grade syndicate at Goldman Sachs.

“They like the risk-reward and the pricing of debt. They see how the situation in the region and for many of those banks has improved in the past few months, and how well the European bonds are trading in secondary markets.”

The search for higher-yielding alternatives to top tier corporate and government debt is pushing investors to some of the riskiest areas of the bond markets in the first weeks of 2013. The demand for eurozone bank debt has been accompanied by a strong reception for US and European junk-rated debt.

“On a relative basis Europe offers more than the US, whether it’s high-yield or bank debt,” says Ashish Shah, head of global credit at AllianceBernstein.

“In order to maintain portfolio performance, you have to rotate into something with a higher beta with improving fundamentals.”

Intesa’s three and five-year debt last week was sold with coupons of 3.125 per cent and 3.875 per cent, respectively. In another blockbuster bank sale this year, Bank of America sold $6bn in three, five and 10-year debt last week.

Both banks carry the same investment-grade rating of Baa2 by Moody’s, but BofA’s three and five year debt was sold with coupons at 1.25 per cent and 2 per cent, respectively.

For investors, European bank bonds also appeal as overall sales of bank debt are still recovering from a drop in issuance in 2010 and 2011.

Travis Barnes, head of US financial DCM at Barclays, says total sales by financial institutions may rise 10 per cent in 2013 to $330bn.

European bank debt “issuers will remain opportunistic and we expect the calendar of new debt sales to be fairly active this year,” he says.

Boosting the prospect for more bank debt sales in dollars, is also the fact that with the euro at current levels there is a market advantage for euro-denominated issuers to sell in dollars, which makes it cheaper for eurozone banks to fund themselves.

“Market conditions are currently in their favour,” says Mr Barnes. “Rates are low, the cross-currency basis swap is attractive and demand is solid.”

Edward Marrinan, head of macro credit strategy at RBS Securities, says an opportunity has opened up for European financial institutions.

“Investors’ desire for yield is overwhelming any reservations they may have about the eurozone and we have seen exceptionally strong demand for European credit, particularly financials.”

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