The rate volatility that plagued bond traders in the first half of 1994 didn't prevent banks from setting another record for issuing debt.
You'd never think of them as rugged individualists, and yet in the first six months of 1994, bankers issued nearly $39 billion in debt securities despite broad market chaos that kept many other issuers at bay.
While overall issuance of debt and equity dropped sharply compared to the first half of 1993, bank issuance soared, according to underwriting information provided by Securities Data Co. Banks issued $40.5 billion in securities in the first six months, with the overwhelmingly majority--$38.9 billion--being debt. The remaining $1.6 billion was comprised of equity issues. That's a significant increase from the same period in 1993, when banks issued $33.1 billion in securities, $28.2 billion in debt and $4.9 billion in equities.
The busiest underwriter in the first half was CS First Boston, which helped raise $7.8 billion, all in debt. It was the first time since the late 1980s that an underwriter other than Merrill Lynch & Co. led the U.S. Banker rankings. Lehman Brothers placed second with total volume of $6.8 billion, all but $350 million of which represented debt securities.
Thrift underwriting, however, followed the trend of the overall markets, falling to $614.6 million from $2.7 billion a year ago. Thrifts did repeat their pattern of a year ago, where proceeds from equity issues outweighed those from debt issues by a two-to-one ratio. Lehman led the thrift underwriting pack, with volume of $199.9 million, all in debt.
The drop in volume for all corporate issuers stemmed from the Federal Reserve's raising of interest rates earlier this year, which Securities Data says had the effect of depressing stock prices on most major exchanges around the world. The total debt and equity issuance for all securities issuers in the U.S. was $441 billion in the first half of 1994, compared to $533.6 billion for the corresponding period in 1993.
Bank Needs Are Unique
The different picture for banks had much to do with the unique funding requirements of domestic banks, and underscores just how different their capital needs are from other corporations. First off, there was a shift in the types of debt issued in the first half--with a clear preference for short-term notes rather than longer-term subordinated debt, although specific totals for each class of instrument were unavailable.
In 1992 and 1993, banks issued stock and subordinated debt to meet regulatory capital requirements, according to Andrew Cooley, a managing director with Merrill Lynch. Those needs have largely been satisfied.
Now, with that steady stream of capital proceeds and two years of record earnings behind them, "banks are less in need of capital than they were," says Thomas Gibbons, senior vice president with the Bank of New York Corp. And since the industry's profits are still close to the record levels set last year, capital needs arising from asset growth in 1994 have largely been met through retained earnings.
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There are still valid reasons for using subordinated debt rather than short-term notes. PNC Bank Corp. issued long-term bonds to help finance its acquisition of First Eastern Bank of Wilkes-Barre, PA. That $330-million deal was completed on June 18, and the portion that wasn't financed through debt was paid from PNC's cash reserves, explains PNC senior vice president Randall C. King.
But clearly there was a general shift toward bank notes, which TABULAR DATA OMITTED have maturities of five years or less, and away from subordinated debt, where maturities typically exceed 10 years. For example, of the $1.45 billion in debt issued by the Bank of New York in the second quarter, most was used to refinance older short- and intermediate-term notes that had matured.
Several other issuers took similar action in the first half. "We were just replacing wholesale liabilities" as they came due, says King at PNC--which in the second half alone raised $2.2 billion in debt, most of which was in short-term notes.
Funding Through Notes
The emphasis on shorter maturities also had much to do with banks' funding needs for loan growth. Notes don't carry the added cost of FDIC insurance, as do retail deposits. According to Dick Downen, NationsBank Corp.'s executive vice president for liability management, that makes them less expensive than instruments like certificates of deposit. For that reason they've become increasingly popular as a means of funding new business, particularly as disintermediation sucks more deposits out of banks' retail operations.
Notes are also preferable to subordinated debt in that they require less paperwork and disclosure with the Securities and Exchange Commission. "A bank note is simply another way to raise money in the markets," says Downen. Still, retail deposits remain the primary source of funding for NationsBank, while bank note financing is chiefly a means whereby it leverages its retail funding.
Large credit card banks such as First Chicago Corp.'s FCC National Bank unit, First USA Bank and MBNA America Bank, N.A. issued debt to securitize card receivables, says Merrill Lynch's Cooley. Regional banks in the Southeast and Midwest, which experienced more loan demand than other parts of the country, issued notes to fund that demand.
All of this activity drives home just how important bank notes have become as a funding mechanism, since they are a more ready source than retail deposits.
"We can grow loans at 10%, and we can grow capital at 10%, but we can't grow deposits at 10%, too," says Paul Martzowka, chief financial officer and executive vice president for Comerica Inc., which raised $1.45 billion in debt in the second quarter. "That is the strategic reason for going to the capital markets. You can't raise that kind of money in the overnight markets." Nor would most banks want to. Using fed funds or repurchase agreements as the primary source of funding would expose a bank to a tremendous degree of rate volatility.
"Sometimes it's very difficult to get retail money on a timely basis," concurs PNC's King. "If you have loans that are closing today, you don't have time to do that."
But given that bank notes tend to have relatively short maturities, the banks that are refinancing maturing issues seem to be in a position where they will be repeatedly returning to the markets. For banks that come to the market regularly, that will expose them to rising funding costs as rates rise. But, as NationsBank's Downen says, rate risk "is inherent in every bank liability." NationsBank was paying yields of 5.25% to 5.5% on notes it issued earlier this summer, whereas a year ago, it was only paying 3.5% to 3.75%. Nonetheless, Downen says that one- and two-year notes are still less rate-sensitive than traditional short-term liabilities such as fed funds, repurchase agreements and retail deposits.
The rising rates also made floating-rate issues more popular with investors. "There's been more interest in floating-rate debt from both the buyer's and the issuer's point of view," says PNC's King. His bank has leaned toward floating-rate notes this year because it could get more preferable rates on them than on fixed-rate issues.
Whether banks continue issuing debt at such heavy levels in the second half depends on several factors, including new loan demand and the cost equation of funding through core deposits versus short-term notes. And of course, there's also the likelihood of further tightening of interest rates by the Fed in the coming months, which is what roiled the markets in the first place.
