Five lessons we’ve learned from sustainable bond investing
The increasing likelihood of tapering from the European Central Bank and the Bank of England will also herald the end of so-called ‘free’ central bank money. Bank treasurers will be busy preparing their 2022 wholesale funding plans as we move into Q4, and this time around that could mean dusting off some very old copies from the early 2000s.
During an update call last week, a senior official at one European lender was more open than most when asked about the timing of a move away from central bank support to a more ‘normal’ wholesale funding approach, saying: “The TLTRO? That’s not funding, we use it entirely as a profit generator.”
The ECB’s stated objective for its Targeted Longer-Term Refinancing Operations (or TLTROs) is to “maintain or increase banks’ lending to businesses and consumers,” so Christine Lagarde and her team may understandably be a little agitated by such comments. In truth, it’s hardly a surprise to hear this.
The current third iteration of the TLTRO, which allows banks to draw three-year loans at 0.5% below the deposit facility rate, has some room to run given it can be utilised until June 2022, so banks’ shift to alternative sources of funding is not a particularly urgent one.
The Bank of England’s £100bn extended Term Funding Scheme (TFSME), however, has a drawdown window which expires at the end of October and provides slightly longer four-year funding. The borrowing capacity is sized against net lending, which has been strong in H1 2021, and we expect banks to make heavy use of their limits.
Tracking bank sentiment towards utilising and exiting these policies is important to us as fixed income investors, since covered bonds and asset-backed securities (ABS) are two key funding alternatives; the ebb and flow in availability of the ECB and BoE programmes has historically mirrored how banks have utilised these markets. UK RMBS from the big high street lenders so far in 2021 for example has totalled £1.4bn, and we don’t expect it to grow much further by year-end. In 2012, before the Term Funding Scheme first came along, the comparable figure was some £18.4bn.
Treasurers are purposefully looking to avoid a ‘cliff risk’ in their funding maturities and so we would expect them to repay or de-risk ahead of the respective three- and four-year permitted windows. Doing this sooner rather than later would appear attractive at the moment given ABS funding spreads have compressed in 2021. We expect more traditional bank ABS issuance in 2022; these tend to be clean, benchmark size deals which can move the total supply needle fairly easily.
However, we are not overly concerned about this likely increase in supply undermining the strong technical that has prevailed in ABS in recent months. Bank ABS issuance is more likely to increase progressively in 2022, accelerating as we move into 2023 given the staggered TLTRO and TFSME maturities. Bank ABS deals also tend to generate the widest investor base and can be issued across currencies, particularly to attract US and Japanese investors. It may create some interesting competition for non-banks, who in 2021 have had the stage to themselves for large parts of the year and so we may see more spread tiering as competition increases. We would also suggest that a broader return by banks offers a unique opportunity to invigorate the green and social ABS bond market in meaningful size.
For some continental issuers that have had favourable funding costs as a result of their AAA bonds being purchased under the ECB’s ABS Purchase Programme (ABSPP), there is scope for any artificial basis to unwind here and we would therefore be wary of longer dated exposures. AAA Dutch Prime RMBS is one such candidate, with bonds trading at a rather rich Euribor+10bp.
While bank treasurers may have to work a bit harder this year-end to formulate wholesale funding plans, the ABS market that they may be more reliant on going forward is experiencing a strong resurgence, which should ease the process of weaning off central bank funding.