Lloyds capital markets chief prepares for market uncertainty

James Garvey has ticked off a fairly extensivelist of banks in his two-and-a-half-decade career in the financial sector. Native to Ireland, he began work with Citicorp in 1987, then moved to UBS, West LB and Goldman Sachs before pitching up at Lloyd’s Banking Group in 2009 as head of capital markets and portfolio management.

In the six years since then, Lloyds has had to cut its cloth to quite a considerable degree. Following a bailout from the UK government and a merger with fellow UK bank HBOS, it has stepped back from global aspirations, and instead focused on UK markets, and UK clients.

That leaves it perhaps more concerned than most about the outcome of country’s general election in May, which promises to be the most interesting for quite some time. The Conservatives and Labour, the two main parties, are neck and neck with a vote share of roughly 30% each. The Liberal Democrats, currently in a governing coalition with the Conservatives, look set to lose a swathe of seats. A hung parliament is the most likely outcome, and the fractured political landscape may make it hard for the largest party to cobble together a functioning government. Coalition negotiations may drag on for weeks.

Early warning

Consequently, Mr Garvey has spent much of this year alerting clients to the market volatility that might crop up during this period. “Capital markets activity is likely to tail off in the weeks leading up to the election. Liquidity could be scarcer than normal with investors less willing to take significant risk positions,” he says. “We have been encouraging clients to get deals completed in good time before election fever takes hold.”

This encouragement has had some effect. Capital markets saw an uptick in activity as early as December, despite ongoing risk from Greece and the eurozone as a whole. Participants needing to complete big transactions or financing programmes have been very busy early on this year. January and February are normally very quiet months, especially for corporates, but there has been activity all across the sectors – financial institutions, sovereign and supranational agencies, and corporates too.

The election could have other, longer term effects on UK capital markets. Labour has been attacked for its often frosty attitude to big businesses, and its promise to freeze energy prices for a certain number of years may stifle investment in the power generation sector just as the country needs it most. Meanwhile, the Conservatives have promised an in-out referendum on the UK’s EU membership by the end of 2017 if it forms the next government. That pledge could cast a pall over capital markets until the referendum votes are cast.

“If we recall at how markets got affected by the uncertainty surrounding the Scottish independence referendum last September, a similar dynamic could take hold with respect to an EU referendum,” says Mr Garvey.

Liquidity overload

Equity capital markets enjoyed a roaring 2014, the busiest since 2007, but on the debt side things were quieter. A lot of big M&A debt deals were discussed but did not come to pass. The M&A deals that did go through were mostly equity based. “The reality is that corporates have enormous amounts of liquidity at the moment. They are in a funding nirvana. If they want to buy something they can often do so from existing cash rather than go to the market for funding,” says Mr Garvey.

The European market in general will soon be awash with liquidity, as the European Central Bank (ECB) cranks its quantitative easing (QE) programme into gear. Up to Ä60bn of government and private sector bonds will be bought by the central bank per month for the next 18 months. By September next year, about €1000bn will have been pushed into the market.

For many it is its effect on deflation that will define the success or failure of QE. In the first two months of the year, consumer prices in the eurozone fell by 0.3%, sparking concerns that the currency zone was on the verge of a damaging deflationary spiral. A recovery in oil prices may help stave off this outcome, but Mr Garvey warns that a prolonged period of falling prices would be difficult for capital markets.

“Most people operating in the market have never experienced a lengthy spell of deflation,” he says. “Corporate executives, bank traders, asset managers, sovereign wealth fund managers have historically operated in an inflationary environment. Trying to predict human behaviour with respect to the timing, pricing and volume of capital market issuance if deflation takes hold will be difficult.”

Balance sheet or brokerage?

When it comes to the portfolio management side of his job, one of Mr Garvey’s biggest day-to-day challenges is how best to use the balance sheet available to him. Given Lloyds’ almost exclusively UK focus, this balance sheet is not as hefty as those at other banks in the City of London.

This often means connecting clients to other financial institutions that are willing to offer funding. This brokerage role has been expanded in recent years, in part due to new Basel regulations that penalise many forms of long-term lending.

“Take UK housing associations, which typically require longer dated financing of up to 30 years and beyond,” says Mr Garvey. “These high-quality assets sit more comfortably on the balance sheets of insurance companies and pension funds than they do banks. So we pioneered some of the first ever housing association bonds, connecting them with institutional investors that need to match these long-term assets with their own long-term liabilities.” Lloyds Bank continues to be the most active bookrunner in this sector, sourcing more than £4.6bn ($6.75bn) of financing for its housing association clients in the past three years.

The bank also reduces capital consumption by laying off credit risk via first-loss transactions with investors.

One tool in reducing balance sheet use is securitisation. Mr Garvey is keen to see such products rehabilitated and back in widespread use after they took a hammering during the financial crisis. “Securitisation is an important component of a bank treasury’s funding arsenal. It is essential for funding and managing the balance sheet,” he says. Mr Garvey believes greater use of securitisation would allow banks to provide clients with greater access to financing, and provide credit instruments that investors would be keen to buy.

Social responsibility

Alongside its London trading rooms, Lloyds also has a fully functioning broker-dealer in New York to provide clients with access to US dollar funding. For Mr Garvey, this is an essential part of the bank’s bond market operations. “Our strategy is to provide financing opportunities in sterling, euro and dollar. This has been a big journey for us. Four or five years ago we had no presence in the bond markets, and now we’re top ranked for sterling and we are very active in the euro and US dollar capital markets,” he says.

One type of bond that Mr Garvey is particularly keen on is the environmental, social and governance bond the bank issued in the middle of last year. At £250m, with a maturity of 4.5 years, it is a fairly small first foray into this type of issuance, but Lloyds promises that there is more to come. 

“Increasingly investors approach us with green and socially responsible investment mandates. Our environmental, social and governance bond, the first by any UK bank, provided an opportunity for these investors to buy a bond from the group in the knowledge that all proceeds will be used to provide loans to small and medium-sized enterprises located in the most disadvantaged parts of the UK,” says Mr Garvey.