Bank unsecured debt market remains unhealthy

The Wall Street Journal reports that despite a shortage of fixed income investments the bank unsecured debt market essentially remains closed.

Regular readers know there are two reasons the bank unsecured debt market is not functioning.

First, to restore investor interest, banks need to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.  Investors need this information if they are going to be able to independently assess the risk of each bank and adjust the amount and price of their exposure.

Without ultra transparency, investors are being asked to blindly bet on the contents of a 'black box'.

Second, central banks have been pursuing policies that favor banks using the central banks as a source of low cost financing.  The result of this has been that banks have pledged most, if not all, their high quality collateral to the central banks.

With banks using so much central bank funding, investors in unsecured bank debt have become even more deeply subordinated than they normally would be.  This increase in risk also drives up the interest rate that the investors need to be paid to compensate them for this risk.

Europe's banks have jumped on the August market rally to sell a type of debt that had been their main source of funding before the sovereign-debt crisis, but analysts warn that the recent rush doesn't signal a return to health, with some deals struggling to attract much demand. 

Banks issuing euro-denominated senior, unsecured bonds-a type of debt backed by a bank's credit-worthiness rather than collateral-have raised €8 billion ($9.98 billion) this month, according to Société Générale data. That compares with nothing last August, and just €4.5 billion the year before, the data show..... 

And with banks repaying bondholders at a faster rate than they are selling new debt, investors are finding themselves flush with cash that they urgently need to put to work, boosting the appeal for banks to sell bonds....

One of the under-appreciated features of setting up funds to invest in specific types of securities is that regardless of what is happening in the market for these securities, these funds will continue to invest so long as they have investable cash.

Managers of these funds say they continue to invest regardless of the risk of the securities because their investors have made the asset allocation decision and want exposure to these securities.

More cynically, managers of these funds invest because telling their investors that they are blindly betting with the investors' cash would not be good for job security.

The recent string of bond deals also shows only the biggest names among Europe's banks have the trust of investors. "We've seen a lot of issuance but it has been top-tier institutions coming to market," Roberto Henriques, a bank credit analyst at J.P. Morgan Chase & Co., said....

Actually, this reflects the belief that the biggest banks are Too Big to Fail and the investors will be bailed out.