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Hedge fund interest could spur Portuguese bank debt revival

Aimee Donnellan
Friday, 1 Nov 2013 | 10:24 AM ET

* Hedge funds seek out high-yielding bank capital trades

* Market conditions rather than necessity to drive issuance

* Economic concerns weigh on mainstream investors' minds

LONDON, Nov 1 (IFR/Reuters) - Hedge funds are clamouring for Portuguese banks to end a four-year absence from the junior bond market after successful issues from Italy's UniCredit and Spain's CaixaBank, debt bankers said on Friday.

Selling so-called subordinated debt would be a big mark of confidence for Portugal's lenders such as state-owned Caixa Geral, Millennium BCP and Banco Espirito Santo (BES) , ahead of the European Central Bank's (ECB) health check of major euro zone banks next year.

Keen to lock in high yields, hedge funds, who normally listen to banks' sales pitches, have instead been picking up the phone to tell bankers they are keen to buy Portuguese bank junior debt.

With such interest from London's Mayfair district, where many hedge funds are based, debt bankers say a new Tier 2 bond could be issued by a Portuguese lender before Christmas.

"There are a lot of Mayfair-based investors that have expressed reverse interest for a name like BES, and it's easy to see where it would price," said a London-based syndicate banker.

"We have had Tier 2 deals from Italian, Irish and Spanish banks now, which makes pricing a Portuguese deal a lot easier as all these reference points are now available."

CRISIS EASING

Portuguese banks have not raised subordinated debt in the last four years as the financial crisis drove the cost of insuring it to 1,650 basis points (bps) at the end of 2010.

But an easing of the crisis has seen this figure drop to a more reasonable 550 bps, and soaring demand for European bank capital may spur them into action.

"The question for Portuguese banks is whether they are willing to pay for Tier 2 today. I think they could issue around 500-750 million euros of Tier 2," said Khalid Krim, Managing Director, Head of European Capital Solutions at Morgan Stanley.

A source in the Portuguese financial sector said some of the banks might want to wait for the Portuguese state to issue bonds before dipping back into the junior debt market.

Portugal made its first benchmark bond issue since its mid-2011 international bailout in May, encouraged by the lowest yields since 2010, but is yet to return to the market after yields shot up again in July.

"It would be good to see the sovereign come out first and show there is appetite for Portuguese debt," said Krim, but added: "Given that there is so much demand for CaixaBank and UniCredit, I don't think people would be surprised to see Portuguese banks in the market."

Millennium BCP, the country's largest listed bank, declined to comment on its capital plans, but a source close to the lender said its financing needs were covered until the end of the year and there was no pressure to go to market.

Banco BPI declined to comment, while BES and Caixa Geral were not immediately available to comment.

BES and Caixa Geral have made tentative steps back into the market for less risky senior and covered bonds since the end of 2012, selling some 2.7 billion euros' ($3.7 billion) worth of paper.

WHILE THE GOING IS GOOD

Strong prices for debt, as fears subside of an imminent cut in the supply of cheap money from the U.S. Federal Reserve, have also meant conditions are good for banks to issue debt.

Since the end of September, the iTraxx subordinated index, which tracks the cost of insuring junior debt, has fallen by almost 40 bps from 213 bps to 177 bps, and Portuguese banks' spreads over the pricing benchmark have tightened by over 70 bps in the same period.

"The market is so strong that banks can sell just about anything at the moment," said Neil Williamson, head of EMEA credit research at Aberdeen.

"If (Spain's Banco Popular Espanol) BPE can sell Additional Tier 1, I don't see why we couldn't see a Portuguese issuer selling Tier 2."

BPE managed to sell Additional Tier 1 debt in October, but it had to offer a chunky 11.5 percent coupon. For the likes of BES and Millennium BCP, bankers say they are unlikely to go beyond an 8 percent coupon for a Tier 2 to begin with.

While hedge funds may be keen, it might be difficult to convince more risk-averse credit investors such as pension funds and asset managers that there is value in one of the highest risk instruments from one of Europe's most troubled economies.

Holders of junior debt are among the first to be hit if a bank gets into trouble, and while Portuguese banks are not at the heart of their country's debt woes - unlike Spanish and Irish peers - Portugal's central bank chief warned this week that the sector faced a tough road ahead.

"Our interest would definitely depend on the type of issuer that was looking to access the market, but I think BES is definitely considered to be stronger than the rest," said a London-based fixed-income investor.

Following the country's bailout by the IMF and the European Union in 2011, Portugal's banks have shrunk loan books to reduce reliance on short-term funding markets and boosted their defences against loan losses.

"Portugal never really had a boom, so it hasn't really had a bust; it's just a very troubled economy that has ruled out a number of investors from looking at it. It is the next weakest economy in Europe after Greece and Cyprus, which warrants caution," said Williamson.

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