Bank issuance of debt defied gravity for most of 1994. But the cumulative effect of the Fed's rate hikes and the annual year-end slowdown finally dampened the busiest market in years.
It was the best of times. It was the worst of times.
That may be the most abused quote from Dickens, but what else describes bank financing in 1994?
Bank debt issuance ballooned to $63.4 billion, by far the largest total in the nine years that U.S. Banker has been ranking underwriters of hank securities. On the other hand, banks' equity issues sunk to $2.2 billion, the second lowest total this magazine has recorded since it began tracking bank underwriters in 1986. The only year with less equity issuance was 1988, when it totaled merely $1.5 billion. The statistics were provided by Securities Data Corp. of Newark, NJ.
Combined debt and equity issuance reached $65.6 billion, also the largest total in nine years. In 1993, banks issued $55.2 billion in securities, and $48.6 billion of that was debt. The equity total in 1994 was only one-third the activity of 1993 and one-fifth that of 1992.
So what gives? Why so many notes, and so few stocks?
"It's a very simple story. There wasn't a tremendous amount of loan demand in 1994," says Gerard Smith, head of the financial institutions practice at Salomon Brothers. Borrowers weren't coming to banks for funding, so banks didn't have to tap the markets. What financing they did do - even after the Fed began hiking rates - was designed almost exclusively to lower their funding costs. As older commercial paper and short-term notes matured, banks retired them and replaced them with one- and two-year notes at lower yields.
Plus, with banks' capital levels at historic highs, there was hardly any need to issue stock.
Hungry for Debt
"The market was hungry for high-quality debt," says Charles White, senior vice president and treasurer at Norwest Corp. Norwest was only too happy to oblige. White's philosophy: "You try to raise capital when the market wants to give it to you, not when you need it."
The $56-billion-asset Minneapolis banking company seemed to be in step with other commercial banks as it retired some old commercial paper and replaced other issues with lower-coupon notes. Norwest issued $1.3 billion in commercial paper and short- and medium-term notes in 1994.
The busy debt market was led by CS First Boston, which was the book manager for $12.8 billion in commercial hank financing. It was the first time in years that Merrill Lynch & Co. did not lead the annual U.S. Banker underwriting survey. Merrill placed second with $10.1 billion. All of CS First Boston's underwriting was for debt issues, and it led that category. Merrill was the book underwriter for $727 million in stock offerings, and it was the leader in that category.
Smith Barney Inc. led thrift financings, as the lead underwriter for $425 million in securities, all of it stock. Goldman, Sachs placed second, underwriting $400 million of thrift issues, all of it debt.
There was $1.4 billion in thrift security issuance, according to SDC. The total was almost evenly split between debt and equity issues, and [TABULAR DATA OMITTED] it was the lowest total for thrift issues in years. In 1993, thrifts issued $3.7 billion of securities.
Of course, not every bank had the luxury of sitting back and feeding hungry investors at its leisure. As in any year, some banks went to the market with a specific funding need. The $150 million in 10-year notes that Crestar Financial Corp. issued in November was such a case.
"We were paying for acquisitions," says Eugene Putnam, a Crestar senior vice president and director of investor relations and corporate finance. The bank added roughly $3 billion in assets during the past year, and Putnam says it needed to issue notes with at least five-year maturities in order to count the proceeds as part of its Tier 2 capital. By issuing 10-year notes, Crestar has five years before it has to start removing some of those proceeds from its capital base.
The $14.5-billion-asset Richmond, VA, bank issued the notes in early November to beat the annual slowdown that dominates the capital markets from Thanksgiving through New Year's Day. It paid an 85-basis-point premium over 10-year Treasuries, says Putnam, adding, "Had we done it earlier in the year, we would have paid 95 basis points."
Selling from Portfolios
As it became more expensive to issue new short-term debt, more banks financed what loan demand they had by selling Treasuries and agency issues from their portfolios, says Salomon's Smith. In addition, retail deposits have declined in cost relative to short-term notes in the past year and that, too, has lessened the need for new notes.
"If you look at third- and fourth-quarter results, you'll see banks are not paying much more for deposits than they were a year ago," Smith says. The Fed Funds rate rose steadily throughout the year, but banks were able to delay raising yields on their low-denomination retail certificates of deposits. For the time being, what funding banks need can largely be met with retail deposits.
It may take some time before the equity markets get hot again for banks, though by the end of last year, the first signs of a wave of stock repurchases had appeared. Smith expects that trend to continue early this year.
"The closer that prices get to book value, the more you'll see stock repurchases," he says. "It's not something banks always like to do. A lot of them issued stock in the last couple of years when they needed capital. Now they'll be buying it back for less than they issued it for. That's a good trade for them, but it doesn't make shareholders happy."