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Sub debt markets stay steady heading into end of year

Aftera slow start to the year, community banks have returned to the subordinateddebt market as a number of market observers urge bankers to take advantage of achance to raise additional capital.

Issuancein the market reached a post-crisis high in 2015, but opened amid broader capital marketvolatility fueled by jitters about global growth prospects, though itpicked up as the yearwent along.

Totalissuance was $4.70 billion in the first quarter, and rose to $6.59 billion inthe second quarter; it had reached nearly $4.60 billion for the third quarteras the end of the period neared. And banks between $1 billion and $10 billionin assets, for whom the subordinated debt can represent important growthcapital, were making up a larger share of issuance throughout the year. Thosebanks issued just $230 million in the first quarter, but the totals rose to$970 million during the third quarter.

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Asexecutives pared back plans for acquisitions and organic growth amid the tumultearly in the year, "there wasn't necessarily as much of a need" forthe subordinated debt markets, according to Kyle Stegemeyer, a senior vicepresident in fixed income at U.S.Bancorp. The company has expanded its correspondent and financingactivities for smaller bank clients in recent years, and last year acted as alead manager on about $317 million worth of Tier 2-qualifying subordinated debtissuance; it has acted as a lead manager for more than $425 million of issuancethis year, according to a spokesperson for the bank.

Despitethat initial slowdown, the factors that have driven activity in the marketsremain largely in place, and investment bankers at the eighth annual M&ASymposium hosted by S&P Global Market Intelligence argued that bankexecutives should strongly consider tapping the market if they need growthcapital. "The after-tax cost of capital is arguably as cheap as it comes …our advice to clients is to take advantage when the market is open," RoryMcKinney, co-head of investment banking with D.A. Davidson, said during a panelat the event late last month.

And though the market serves a relatively small number ofinstitutional and other bank-focused investment players, Stegemeyer said thatthe investor base is slowly broadening — and the banks' subordinated debtofferings look increasingly attractive in global debt markets that are offeringscant returns.

"Investorsright now are looking for yield anywhere and have come to the conclusion thatbank balance sheets are strong. If you're a half-billion-dollar bank that canissue [subordinated debt] at 6%, that's fantastic," Bill Burgess, aprincipal in investment banking with Sandler O'Neill & Partners, saidduring a conference panel. Bankers who are hesitant that taking on moresubordinated debt could complicate a potential sale in the future should stillmake the leap if they see growth opportunities.

"All you're going to do is leverage that capital andmake your franchise more valuable down the line," Burgess said.

Banks may have other reasons for tapping the market as well.Banks with concentrations in commercial real estate loans are making up alarger portion of issuers in the market, Raymond James Financial analysts saidin a recent note to clients, and issuing sub debt may be a response toregulatory focus on risks in the CRE market. "We can't help but think thata byproduct of additional subordinated debt issuance is to bring CREconcentration down to prove to regulators their warnings are being heard,"they wrote.

The average CRE concentration for issuers of sub debt so farin 2016 is 257%, up from an average of 189% in 2015, according to the analysts;more than half of issuers this year have a concentration of more than 200%,which is nearly double the rate of issuers with that level of concentrationlast year.

While that regulatory pressure could bolster demand amongbanks for the balance of the year, the risks of the sort of global volatilitythat dampened the market early this year have risen in recent weeks withconcerns about Deutsche BankAG's capital levels and continued Brexit fallout. But Stegemeyersaid that the specialized nature of the investors in the space may work to itsbenefit as long as there are no major disruptions to global markets. "It'sa relatively niche product, and because of that there is some insulation … tothe broader global risks," he said.