Financial Times Europe - 19.09.2019

(Jacob Rumans) #1

Thursday19 September 2019 ★ FINANCIAL TIMES 21

bank bonds despitehigher default risk.
Perps rank behind most debt securities
inpriority for collecting repayment ni
the event a bank goes bust. “Perps could
neither offer upside potential like stocks
nor security like bonds,” said the inves-
tor. “I don’t see a reason to hold them
unless they offer a very high yield.”
Investors agree that the potential
influx into the perp market of smaller
banks ould require greater scrutiny.w
“It is difficult to predict when small issu-
ers may run into trouble,” said Qi Sheng,
an analyst at Zhongtai Securities in
Shanghai. “You need to have particu-
larly strong credit analysis capability.”
The CBS operationraises the question
of state intervention, as it would allow
Beijing to inject liquidity directly into
thesystem. The People’s Bank of China
has shrugged that off, saying it will keep
perps off its balance sheet while leaving
credit risks to commercial banks.
But analysts have doubts.Mr Zhao
said the central bank would have little
trouble tweaking its rules. “If a financial
crisis hits China, the PBoC could easily
turn debt swap into an official purchase
of securities in order to increase credit
supply,” he said. “We are not there yet.
But the central bank has created the
mechanism that allows it to do so.”

the highest possible collateral they can
get,” said Zhao Wenzhe, an economist at
Credit Suisse in New York.
The Bank of China director said perps
carried low risk despite the threat of a
write-off, which is triggered when the
issuer’s capital ratio drops below a cer-
tain level. “If we end up writing off the
security, everyone else will default as
well,” said the banker.
Not everyoneis persuaded. A Shang-
hai sset manager said he would nota
consider buying bank-backed perps; the
securityoffered a similar and, in some
cases, lower return than traditional

Thecapital shortage n the sector isi
reflected in an FT analysis of 33 listed
China banks, using Wind Financial data.
This shows 21 of them — including the
big four tate lenders — fell short of capi-s
tal requirements set out by global regu-
lators, as at the end of the second quar-
ter this year. “Our capital ratio is among
the lowest in the global banking sector,”
said a Bank of China director involved in
the lender’s perp ssuancei. “We need to
lift it to the industry average.”
In the past, China banks relied on
preference shares to improvecapital
levels. But this avenue is limited to listed
lenders, andmany unlisted lendersare
undercapitalised. Preference share issu-
ance also suffers from a lengthy
approval process andlack of liquidity.
Perp onds, which qualify as addi-b
tional tier one capital, offer an alterna-
tive for banks seeking to shore up their
capital base. The security is available to
public and private lenders, which
makes it a powerfultool for small banks.
Perpscome with a feature called cen-
tral bank bill swap, which helps improve
the instruments’ liquidity.It allows
dealers temporarily to swap perp ondsb
for central bank bills and to use the lat-
ter as collateral to obtain cheap credit.
“CBS is giving perpetual bondholders


China’s banks are racing to issue
domesticperpetual bonds s they seeka
to top up capital levels to meet tighter
rules, with about Rmb810bn ($114bn)

The embrace ofperps s part of an efforti
by Beijing to shore up thefinancial sys-
tem as the economy loses steam, and
after a crackdown on theshadow ank-b
ing sector, in which many banks had
invested, put several under stress.
The need for China banks toraise cap-
ital as intensifiedh as Beijing,in a trade
war with the US, counts on domestic
lenders to stimulate growth.
“Chinese regulators want banks to cut
shadow banking investment and
increase traditional lending,” said Nico-
las Zhu,an analyst atMoody’sin Beijing.
In January,Bank of China ecame theb
first China lender to issue Rmb40bn in
perp onds with a 4.5 per cent coupon.b
Since then, eight lenders, ranging from
leaders such asICBC o regionalt partici-
pants such asChina Bohai, have fol-
lowed, taking the total to Rmb410bn.
Momentum is expected to continue,
with eight more banks preparing to
raise up to Rmb400bn by issuing perps,
according to company reports.

pressure on the overall business. These
are incremental dollars we didn’t think
about before, that we are now trying to
bring into the firm.”
The motivation is somewhat different
atGoldman Sachs, where chief execu-
tiveDavid Solomon as been aiming toh
build relationships withexecutives at
smaller companies, hoping that they
can boost the bank’s investment bank-
ing revenues.
Steve Strongin, the bank’s global head
of research, said: “The shift is very real.
There is a broader recognition that
re s e a rc h c a n b e u s e f u l t o o u r
clients... beyond the investment
Research divisions ithin banks oftenw
have staffing and resources that dwarf
the biggest think-tanks and consultan-
cies, churning out huge amounts of
industry, economic and financial
research, from simple stock recommen-
dations to machine learning-driven
analyses of corporate sentiment. Total
commissions paid by US fund manag-
ers, covering both research and trading,
came toalmost $8bn ast year, accordingl
toGreenwich Associates, down from a
peak of $14bn in 2009.


Goldman Sachs nda Morgan Stanley
Bain nda McKinsey, hoping to sell
research ervices to companies to off-s
set big falls in demand from their tradi-

Historically, the reams of research and
economic analysis produced by Wall
Street’s army of “sellside” analysts has
been targeted at hedge funds and fund
managers — the “buyside” in industry
But investment groups have come
under ferocious fee pressure in recent
years and are trying to cut down on
costs. At the same time, newregulations
stemming from the EU — and which
have washed over the US — have
required banks to charge investors for
the research they provide, rather than
bundling the cost into commissions for
As a result, fund managers have
slashed budgets for spending on
research, spurringbanks o look for newt
opportunities in the corporate world.
Simon Bound, global head of research
atMorgan Stanley, said: “The catalyst is


Fixed income

China lenders look to boost capital by issuing perps

Cross asset

Wall St rivals seek research

clients beyond fund industry

Regulators want lenders ‘to cut
shadow banking investment’

Our global
team gives you
news and views,
24 hours a day


One of the most important sources of
financial market lubrication came
under severe strain this week, raising
concerns that the Federal Reserve’s
attempt to unwind post-financial crisis
intervention may have gone too far.
Repurchase agreements are the
grease that keeps the financial system’s
wheels spinning, allowing different
market participants to borrow and lend
to each other to cover short-term cash
On Tuesday, the wheels stopped turn-
ing. The so-called repo ratesoared to a
high of 10 per cent, when it typically
trades in line with the Federal Reserve’s
target interest rate of between 2 per cent
and 2.25 per cent. The New York branch
of the Fed had to step in and inject tens
of billions of cash into the system in an
attempt to restore order,with a second
short-term njection yesterday.i
But what exactly is going on? The
answer lies in both idiosyncratic short-
term issues and big, structural changes
in financial markets that have occurred
as the Fed as unwound the huge pur-h
chases of bonds it made to boost the
economy after the financial crisis. The
reason it is getting so much attention is
that it raises the possibility that the Fed
may have gone too far, inadvertently
loosening its grip on monetary policy.

Why now?

Tax day for companies in the US is Sep-
tember 15. Some companies prepare by
pooling the cash they need and placing it

into money market funds — short-term
investments that use the repo market to
lend out cash for abrief period, earning
a small return. Now tax day has passed,
that cash has been yanked from the
market, reducing the supply of dollars.
At the same time, roughly $54bn of
Treasury securities have flowed into the
market because of the settlement of a
host of previously auctioned debt. This
has created a wave of demand from peo-
ple wanting to borrow cash to finance
the purchase of these Treasuries.
In simple terms, demand for cash is
higher at the same time as the supply of
cash is lower.Analysts say these two
thingsalone should not cause the deep
cracks in the repo market that we have
seen this week. The underlying issue is
more structural.
The Fed as been reducing the size ofh
its balance sheet, letting the Treasuries
and mortgage bonds it bought following
the financial crisis roll off. In turn, that
reduces the amount of cash reserves
bankshold at the Fed. In 2014, banks
held $2.9tn in “excess reserves” with the
central bank. Since then, that number
has dropped toabout $1.3tn, where it
has hovered all summer.

Fewer cash reserves means less
money available at the banks to cover
short-term funding stress.
“We have had tax payments in the
past. What is different this time is that it
has followed a period of quantitative
tightening,” said Jon Hill, an interest
rate strategist at BMO Capital Markets.
“Companies sucking cash from the mar-
ket was just the tripwire that brought
things falling down.”

Are reserves too low?
A paper by the New York Fed in June
suggested the minimum level could
beabout $1tn.
Lorie Logan, head of Market Opera-
tions and Market Analysis at the New
York Fed, said in a speech in 2017 that
we will know that level when we see it.
The latest ruction in repo markets is
therefore highlighting that perhaps
bank reserves are too scarce, jamming
up the supply of cash in financial mar-
kets. That is: we might have reached the
level Ms Logan was talking about.

Could it get worse?
Yes. Since Ms Logan’s speech, the Fed
has ended its balance sheet reduction

and is holding it constant. Effectively, its
assets are at a stable level.
On the other side of the Fed’s alanceb
sheet sit a few big-ticket items. Bank
reserves are one, but how much cash the
US Treasury holds is another.
The US Treasury used to hold as little
as $5bn in its cash account at the Fed.
But since 2015, the Treasury has held
enough cash to cover a week of outflows
— about $400bn. On September
11 , Treasury secretary Steven Mnuchin
had only $184bn on hand, which means
that right now he is under pressure to
get the balance in his checking account
back up.
Another is the simple growth of cash
currency in circulation, which tends to
grow roughly in line with GDP, saidBMO
Capital Markets’ Mr Hill.
As these two things grow, something
has to fallto keep liabilities matching
assets. That is putting further down-
ward pressure on the level of bank
reserves, draining even more cash out of
the market.

What can be done about this?
A few things. The Fed could lower the
interest rate it pays on bank reserves, sa
it tries to keep other short-datedrates —
like repo — within its target range.
The Fed could also start to grow its
balance sheet again more quickly than
expected to keep up with the pace of
currency growth and US Treasury cash
increases. Finally, the Fed ould set up ac
standing repo facility.
“These are somewhat uncharted ter-
ritories,” said Janaki Rao, a portfolio
manager at AllianceBernstein. “Mone-
tary policy was made up on-the-go dur-
ing the crisis, and we are dealing with a
changed paradigm,where the Fed has to
work to understand and come up with
new solutions to deal with it.”
Additional reporting by Colby Smith

Analysts question whether US

central bank has inadvertently

loosened its monetary grip

The New

YorkFed on

had to step
in and

inject tens
of billions of

cash into
the system

in a bid to


The Federal
Reserve has a
number of tools
to ensure the
wheels keep

Cross asset. inancial stabilityF

Soaring repo rate puts

spotlight on Fed policy


Sanjeev Gupta, the UK metals magnate,
has offered to put in $150m of his own
money as he attempts to sell a debut
high-yield bond.
The industrialist hired investment
bankJPMorgan arlier this month toe
help raise$475m of new five-year debt
for hisInfraBuild usiness, an Austral-b
ian steel and recycling company that
shelved plans for a stock market flota-
tion earlier this year.
InfraBuild isscaling back the bond
deal to $325m because of lacklustre
demand from bond fund managers,
with Mr Gupta offering to put in the
remainder himself as equity. High-yield
bond investors had already wonhefty
concessions rom the businessman,f
with InfraBuild having to offer them a
stronger claim on the company’s assets
and a yield around the 10 per cent mark.
Several bond fund managers have
said the deal has struggled due to con-
cerns about the opaque nature of Mr
Gupta’sGFGAlliance group, a loose
association of mostly private businesses
controlled by Mr Gupta and his father.
GFG’s funding strategy has come
under increased scrutiny, as his busi-

nesses have previously relied heavily on
invoices and supplier payments, rather
than traditional capital markets.
Australian financierLex Greensill, a
confidant of former UK prime minister
David Cameron, has provided much of
the financing for GFG’sexpansion over
the past few years. The InfraBuild bond
is intended to repay A$545m ($373m)
of funding from the financier’s epony-
mous firmGreensill Capital, as well as a
further A$200m fromWhite Oak, a San
Francisco-based lender to medium-
sized businesses. White Oak’s A$200m
facility carries a double-digit annual
interest rate, according to people famil-
iar with the matter.
Fitch confirmedyesterday that it
would raise InfraBuild’s bond rating one
notch to BB if it is scaled back to $325m
and its collateral package is improved.
The rating agency added that the
improved grade was contingent on the
“success of the proposed bond issue”
and Fitch receiving final documents
conforming to the information it has so
far received on the planned changes.
InfraBuild needs toraise the bond in
order to unlock a further A$250m romf
JPMorgan. The US bank has agreed to
provide an asset-backed lending facility
to the Australian business, but only if
the bond deal is successful.
InfraBuild comprises the recycling,
distribution and construction products
operations of the former Arrium, an
Australian steel and mining group.
JPMorgan andGFG Alliance eclinedd
to comment.

Fixed income

Metals mogul

Gupta offers

$150m to help


bond succeed

InfraBuild is scaling back

the deal to $325m because
of lacklustre demand

from fund managers

US overnight repo rate surges
Per cent

Source: Refinitiv

Aug  Sep
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