To cover a capital shortfall of €50 billion.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
New language can often serve as a cryptic signpost to the future. This is particularly true in finance. Take the expression “Too Big to Fail.” Within months of the fall of Lehman Brothers, the expression was being used so widely that it ended up being abbreviated to the now instantly recognizable TBTF.
For the captains of the global financial industry in their plush seats on the Basel-based Financial Stability Board, a TBTF bank was too simple and vulgar an iteration, so they coined a new term with a little more gravitas: Global Systemically Important Bank (or G-SIB).
Now a new word is coming into common use: “bailinable” (bail-in-able).
Bailinable debt consists of hybrid debt securities that automatically convert into equity and/or have their face value mercilessly slashed if some pre-defined trigger is met (usually linked to the issuer’s capital). It includes subordinated debt and high-risk instruments like the contingent convertible (CoCo) bonds that are designed to be bailed in first when a bank gets in trouble. Deutsche Bank’s CoCos famously crashed earlier this year, as did many other bank CoCos, but they’re once again in vogue.
Bailinable debt comes into play when a bank is about to go belly up. Part or all of the debt can be used to “bail in” a bank before taxpayers are called upon to cough up the rest. By providing additional resources when needed, bailinable debt should reduce the need for publicly funded bailouts in the resolution of bankrupt banks.
It’s the way it should have been from the very inception of this global banking crisis. Instead, governments and central banks have injected trillions of dollars, euros, pounds, yen, and yuan of public funds into banks’ hole-riddled balance sheets, while most bondholders have been made whole, including those holding subordinated, or junior, debt, which is theoretically designed to bear losses in times of stress.
Now, thanks to regulatory changes at the European and global level, some bondholders may have to finally begin paying the price of risk. But it’s unlikely to be senior bondholders. According to the Basel III Total Loss Absorbing Capacity requirements for global systemically important banks (yeah, them again), set by the Financial Stability Board, senior unsecured bonds will remain at the top of the fixed-income pile. That means they won’t be part of a bank’s total loss absorbing capacity and won’t be subject to the new bail-in rules.
That’s reassuring news for senior bondholders, but it’s not such good news for the TBTF banks that are facing regulatory pressure to issue increasingly more bailinable debt. Investors don’t like this kind of debt and demand higher yields. So this debt is expensive for banks. But as the pressure rises, we are likely to see a surge in issuance of riskier and presumably higher-yielding, and therefore costlier bank debt.
But France has figured out a way to pull a bag over investors’ heads with its newfangled class of bailinable debt – or rather a newfangled name for it.
France is home to four G-SIBs (twice as much as Germany and Italy combined): BNP Paribas, Crédit Agricole, Groupe BPCE and Société Générale. According to analysts at ABN Amro, the four banks have a total eligible capital shortfall of €50 billion, that will need filling by 2019:
Under our calculations, BNP Paribas currently has the largest shortfall, and it would require EUR 26 bn of eligible capital. The other three French banks also all have eligible capital shortfalls, albeit smaller… (EUR 24bn for the three other banks combined), approximately 1% of their risk weight assets.
To help fill some of those holes, financial engineers in France have kindly created a new debt class called senior non-preferred bonds (AKA senior junior, senior subordinated or Tier 3), which have been hastily accepted by France’s market regulators. Within days of the regulatory change Credit Agricole had issued €1.5 billion of the 10-year bonds. Société Générale is preparing its own five-year offering, and BNP Paribas is poised to follow.
It’s just the beginning. According to ABN Amro, there could be total funding capacity of as much as €93 billion for this new debt class. And that’s just in France. Spanish banks are also keen to begin issuing senior non-preferred debt; they’re just waiting for the regulatory authorities to make the necessary tweaks.
The new debt will be positioned in the hierarchy of creditors between subordinated debt and the pre-existing senior unsecured debt. Its holders will be subject to bail in before senior bondholders (who apparently won’t be bailed in at all) but after junior bondholders. The new class of senior non-preferred debt will apparently have 100% TLAC loss absorbing capacity eligibility for capitalization requirements, meaning that if a bank is resolved, holders of these instruments could lose much or all of their money.
So much for the “senior” half of the bond’s name. The senior non-preferred bond pretends to be simultaneously one thing (senior), in order to keep the yield (and the cost for the bank) down, and another (junior) in order to qualify as bailinable. As Bloomberg reports, while the debt is pretty junior, it comes with pretty senior price tags:
Credit Agricole is only paying about 45 basis points more to issue senior non-preferred bonds than it would to sell traditional senior debt and about 65 basis points less than it would for subordinated.
That doesn’t look like a generous premium for a security that comes with its own mystery: how can investors consider a bond that can be bailed in as truly senior?
The answer is they can’t. But we have to admit that this is a beautiful name for a great scheme to bamboozle bondholders – usually institutional investors like our beaten-down pension funds – into buying something with other people’s money that doesn’t yield nearly enough to compensate them for the risks they’re taking. By Don Quijones, Raging Bull-Shit.
The European Court of Justice refused to listen and it ruled. Read… Nightmare Before Christmas for Spanish Banks
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