Lower Rates Lure Banks Back to Capital Markets
Drawn by low interest rates and eager underwriters, banks rushed into the bond market this week.
Since Monday, banks have issued $1 billion in subordinated and senior debt. And capital markets specialists say the trend should continue.
"The time comes when you want to replace maturing debt, get your name back in the market, or supplement your capital," said Jay Weintraub, a first vice president at Merrill Lynch.
On Sidelines Until Now
Except for a flurry of new issues early this year, banks have stayed on the sidelines as rates notched down.
But bankers apparently view the cuts in recent days as an opportunity to obtain cheap financing before they prepare yearend financial reports.
Several factors are propelling banks into the market. Some banks are eager to lock in long-term funding and capital while interest rates are low.
Treasury Yield Dropping
Ten-year Treasury notes were yielding 7.42% Thursday afternoon, compared with 7.81% at the beginning of September.
Chase Manhattan Corp. issued $150 million in 10-year subordinated debt Tuesday, and its interest payments are set at 9.75%.
The last time Chase paid such a low rate for subordinated debt was 1989.
Other issuers were prepared to come to market earlier in the fall but preferred to wait until banks had released their third-quarter earnings. There have been only a handful of bank debt offerings in the past two months, so this week's activity appears partly to reflect pent-up demand.
Some banks are in the market because they received bids from would-be underwriters that translated into interest payments smaller than the yields on their outstanding issues.
For example, First Interstate Bancorp issued $150 million in 10-year subordinated medium-term notes at a yield of about 10%, 250 basis points over the yield on comparable Treasuries.
That's lower than the current yield of roughly 10.2% on First Interstate's outstanding subordinated debt, suggesting that underwriters were willing to pay a high price to get the Los Angeles bank's business.
Several strong banks were lured into the market by the prospect of issuing debt at tight spreads relative to Treasuries.
In one offering, Bankers Trust issued $300 million in five-year senior notes at a yield of 7.329%, just 60 basis points higher than comparable Treasuries.
Similarly, J.P. Morgan & Co. issued $250 million in seven-year notes priced at a yield of 7.647%, just 50 basis points over comparable Treasuries.
And Republic New York Corp. issued $150 million in 10-year notes at a yield of 8.32%, a mere 80 basis points over comparable Treasuries.
Tight spreads are important to trading-oriented banks like Bankers Trust, Morgan, and Republic. "It's totally spread-related," said a banker at one of the issuers.
That's because tight spreads make it easier for banks to convert their interest payment obligations to low-cost floating-rate obligations through a swap contract.
Take for example that Bankers Trust wished to swap its interest payments from Monday's issue into floating-rate obligations.
At this week's swap rates, it could have locked in floating-rate payments at about 10 basis points over the London interbank offered rate -- a low cost even for a well-regarded bank such as Bankers Trust.
Alternatively, if a bank thought swap rates would eventually improve, enabling it to convert to even lower cost floating-rate obligations, it could purchase a Treasury of the same maturity as its own issue to lock in its fixed-rate cost while it waited for swap rates to change.
If Bankers Trust did this, for example, the interest it received on the Treasury note it bought would offset part of the interest it paid on its own notes, effectively locking in an all-in cost to the bank of 60 basis points.
Slack Demand for Issues
Several of this week's issues are selling slowly. "I can't imagine [any underwriter] is making any money on these deals," said one capital markets specialist.
Experts say more banks could tap the market before long. Intermediate and long-term Treasury prices have risen less than those on short-term Treasuries, so many dealers seem poised for an increase, according to William Downes, a vice president at Keefe, Bruyette & Woods.
That means they are willing to bid aggressively to get underwriting business, and banks will probably respond, he said.
"Dealers like the market," he said. As a result, banks have a window of opportunity right now to get deals done.