Reuters: Bankruptcy News: EC opens door for new subordinated asset class

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EC opens door for new subordinated asset class Jun 8th 2012, 16:07 Fri Jun 8, 2012 12:07pm EDT * New instruments could form buffer between reg capital and senior debt * Cost-effectiveness uncertain given upcoming higher capital requirements * Outstanding hybrid capital not compliant with CRD4 could be utilized By Helene Durand LONDON, June 8 (IFR) - European banks seeking to protect their senior bondholders from being bailed-in were given a lifeline by the European Commission this week when it opened the door for banks to issue specific bail-inable debt. However, the jury was still out as to who would do it and what the cost benefits would be. The long-awaited Crisis Management Directive draft finally published on Wednesday explicitly allows banks to issue specific subordinated debt instruments that would absorb losses after regulatory capital but before any senior debt. The debt would be different from Tier 2 and Additional Tier 1 under CRD4. Bankers are hopeful the asset class could grow substantially and make up a large part of the subordinated debt market which has ground to a halt due to regulatory uncertainty and reduced investor appetite. "The draft Directive allows for a new class of bail-inable bonds which could be issued in significant size," said AJ Davidson, head of hybrid capital structuring at RBS. "Given that the maturity could be between one and five years, in theory, it could be cheaper than Tier 2 debt that needs to have at least a five-year maturity. Banks could use this layer as part of their funding and capital management strategy." His view was echoed by Gerald Podobnik, co-head of capital solutions at Deutsche Bank. "The extra layer between a bank's own funds and its senior debt should protect the latter and therefore allow banks to build a cushion which should make senior debt less risky and therefore less expensive." Bankers and analysts differentiated the potential new debt asset class from the now-defunct Tier 3 which never really took off. Tier 3 only absorbed potential losses in a bank's trading book and had a soft maturity. "This could potentially be much simpler and, while for the safer banks it might not make much difference funding cost-wise, it could be useful for other banks," said John Raymond, analyst at CreditSights. Investors also welcomed the prospects of an extra layer of protection of bail-inable liabilities that sits ahead of senior. Andrew Fraser, FIG analyst at Standard Life said that if regulators ask banks to hold substantial amounts it would help lower the cost of senior funding and show that regulators want a functioning senior market. TOUGH CHOICE Some bankers questioned if the extra layer of subordinated debt would lead to an improvement in senior bank debt pricing, especially as, unlike covered bonds, for example, senior would still be captured by bail-ins. Banks could choose to issue subordinated 'bail-in bonds' or simply issue more Tier 2. "Tier 2 provides a buffer for senior unsecured creditors because it acts to prevent a bank falling into resolution. 'Bail-in bonds' also provide an extra buffer but only trigger in a resolution so won't stop a resolution from occurring - they just reduce the likelihood of bail-in happening. What would senior unsecured investors prefer?" asked Daniel Bell, head of EMEA DCM new product development at Bank of America Merrill Lynch. He added that, while bail-in bonds ought to be cheaper to issue than Tier 2, issuers would have to look at the benefit from issuing them versus Tier 2 and what difference it would make to senior funding costs. "If banks run 15% capital ratios, does 1% or 2% of bail-in bonds make any difference to funding costs? Until that is quantified it probably doesn't really make sense to issue bail-in bonds." And Etay Katz, a partner at law firm Allen & Overy, does not see an immediate advantage of issuing this type of subordinated debt unless there is a particular tax or regulatory advantage in doing so. "Banks will more likely issue senior debt that is subject to bail-in." But for Antoine Loudenot, head of capital structuring at SG, instead of issuing new subordinated debt, banks could use that layer to utilise outstanding Tier 1 and Tier 2 debt that will not be recognised as regulatory capital post CRD4 and would otherwise lose value for banks. The ultimate decision will likely be institution-specific and largely a function of whether the average price banks pay is better by issuing both; and presently that is a very difficult calculation. Although senior debt investors welcome the idea of layers of loss-absorbing debt beneath them, it remains to be seen whether they will want to be the providers of that cushion. So far, new-style instruments, such as Additional Tier 1, envisaged under the upcoming European framework, have received nothing but negative feedback from fixed income investors, who have said that they do not like features such as permanent write-downs and lack of dividend pusher or stoppers. The subordinated debt as spelled out by the Commission could either be written down or converted into shares in order to recapitalise the bank, which could make investors reluctant to buy it. (Reporting by Helene Durand; editing by Alex Chambers, Julian Baker) Link this Share this Digg this Email Reprints

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