But investors are burned out.
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
After countless scandals, near-death collapses, bail-outs and bail-ins, Italian lenders are finding it increasingly difficult to attract investors. The amount of Italian bank bonds outstanding has shrunk by about 30% since the start of 2015, according to Marcello Minenna, the head of Quantitative Analysis and Financial Innovation at Consob, the Italian securities regulator.
The decline in volumes has been accompanied by rising yields on subordinated and senior unsecured notes. This is a big problem in a country where bonds represent an important share of banks’ liabilities, especially at a time when the big European banks are facing increasing regulatory pressure to issue ever larger volumes of what has come to be known as “bailinable (as in bail-in-able) debt.”
Bailinable debt traditionally 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.
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’s investors before taxpayers are called upon to cough up the rest. It’s what should have happened from the early stages of the financial crisis. But for bankers there’s a big problem with this kind of debt: given its high associated risks, it normally comes with a hefty price tag, particularly if the bank in question fails to inspire confidence among investors.
To get around that problem, financial engineers in France conjured into existence a whole new debt class in 2016 called senior non-preferred bonds (AKA senior junior, senior subordinated or Tier 3), which were hastily accepted by France’s market regulators, endorsed by the European Commission, given a stamp of approval by rating agencies, and fast-tracked into use by France’s four Too-Big-to-Fail banks, which were desperate to fill an estimated eligible capital shortfall of €50 billion.
The newfangled debt class was positioned in the hierarchy of creditors between subordinated debt and the pre-existing senior unsecured debt. Its holders would be subject to bail in before senior bondholders (who apparently won’t be bailed in at all) but after junior bondholders. In other words, 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.
It’s a way for big banks 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. And for the moment it appears to be working.
In its first issuance of senior non-preferred bonds, Credit Agricole only paid about 45 basis points more than it would to sell traditional senior debt and about 65 basis points less than it would for subordinated. Since then, the practice has spread beyond French borders. Early this year Holland’s ING and Spain’s Santander began issuing senior non-preferred bonds even though their issuance had not yet been officially sanctioned by each bank’s respective national regulator.
In June Spain’s government hurriedly passed a law endorsing the new financial instruments. In the interim Santander has issued its second €2.5 billion batch of the bonds and has plans to issue a whole lot more. In August Spain’s second biggest bank, BBVA, placed €1.5 billion worth of senior non-preferred bonds, apparently “at the best price ever” in Europe (from the bank’s perspective), according to BBVA’s own website.
Now, it’s the turn of Italy’s struggling lenders to join the party. On December 28, the Italian Parliament approved the Italian Budget Law for the 2018, which provides, among other things, for amendments to Italian laws aimed at permitting the issuance by Italian banks of “non preferred” senior bonds. Italy’s fragile super bank, Unicredit, has been chomping at the bit to issue such bonds. Soon it will get the chance, but will investors buy them at a low enough yield?
Fears about the health of Italy’s toxic debt-laden banking system still abound despite the controversial rescue last summer of Monte dei Paschi di Siena (MPS) and the resolution of Popolare di Vicenza and Veneto Banca. There are few better barometers of investor sentiment than the shares of “rescued” Monte dei Paschi, which have done nothing but lose value since resuming trading at the end of October. On Friday they closed trading at €3.93, a far cry from the €6.49 a share the Italian government paid in August when it injected €3.85 billion into the bank to keep it alive.
Against this backdrop, Italian banks will need to raise as much bailinable debt as possible over the coming months. Recent simulations performed on the top 162 EU banks in terms of Tier 1 capital showed that Italian banks have minimum required eligible liabilities (MREL) of between 11.7% and 13.3% of total assets, considerably higher than their French, German or even Spanish counterparts. Under the new EU rules Italian banks will need to add between €79 and €111 billion in subordinated debt financing.
It’s a tall order, especially after the bail-in of €5 billion of subordinated bonds this summer. Investors are already smarting and as Marcello Minenna, the head of Quantitative Analysis and Financial Innovation at the Italian securities regulator, warns, the new class of non-preferred bonds may simply be seen as subordinated bonds under a different name, and what’s more offering lower yields.
While yield-starved investors may be desperate for returns of just about any kind after years of heretofore unprecedented financial repression, there’s still a limit to what they’ll buy. While that limit may be ridiculously low, it could soon be tested in Italy, especially now that the only marginal buyer of Italian sovereign debt, the European Central Bank, is poised to withdraw from the market, which could trigger a whole new round of fear and mayhem in the Euro Zone’s third largest economy. By Don Quijones.
“With Friends Like These – ” Read… The Inconvenient Limits to European Unity & Integration
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The merry go round casino with players ( banks government political manipulation losses and write offs where’s the money going to I guess a big black hole in dept ridden taxpayers pension funds and savings
Financial experts who are in limbo but still get their fees for jumped up soluciones which are worthless
When boys have money they think they’re men when the moneys gone they’re boys again 2018 will be the same trend I expect the World circus of financial animales
Especially since they changed the accounting rules back in 2013, I think. Where the EU have allowed banks to value securities at mark to book values and not mark to market.
What the politicians in Europe do not understand is that they have put their lives on offer when all this unravels. Jo Cox should have been the canary in the coalmine. When folks are losing and they have nothing else to lose, they lose it.
The Italian banking system will glom as much as it can for nothing or less. They will smile, charm, distract, and be your best friend. The eurozone managers will impose rules. The Italian banking system will pick the ones they choose to follow and get fuzzy after that.
I suspect … just as Draghi is playing the world with ECB QE and debt monetization while on the frustrating hunt for inflation just to keep the eurozone alive and kick the can another day, the Italian banking system is playing the eurozone in a like way. No Italy, no Eurozone.
I am so looking forward to the post-collapse tribunals for these criminal banksters and their enablers among our political elites.
Everything they are doing is legal. That’s the problem.
As Will Rogers, and many before him, observed, “the return of my investment is more important than the return on my investment.”
When the [uncompensated] risk is considered, IMNSHO, the “institutional investors” would be better off holding cash than chasing [the illusion of] yield. The return is minimal and the risk considerable.
Mcduffee- Excellent pertinent quote . The adages of the past still have validity. Maybe explains why the long term treasury market has yet to see an increase in yields . The highly liquid US government bond market offers attractive yields relative to the other countries debt offerings .
As the Global economy slowly tightens, It becomes a case of when, for much of france greece and club meds Banking.
One would probably be safe “Investing” in Argentina or Venezuela than the Banking Systems of france greece and club med.
Sane peopel, Along with ethical investment managers, do not “Invest” in garbage, such as that described in the article,.
When the Brexit UK leaves the EU (IF EVER) we will have to Wipe Our Feet of the Galloping Corruption .
Another EU bank fudge…now that is news.
“senior non-preferred bonds”
I suppose the author attempted to say these are bailinable but it wasn’t totally clear.
Personally, I steer clear of the eurozone.
Happy New to you and your family.
Great article, really interesting.
At the end of 2016, Italian Banks if I remember right had roughly 300 billion euros of NPL’s on their books, what’s the figure looking like now?
Unicredit for example were selling off 25 billion euro’s of NPL’S for a big mark down to Debt Management Companies.
Since 2008 I have considered the purpose of the EU project to be little more than a life support system for the financial sector.
We are approaching a decade in and all we have is the rube goldberg (the rube is vital) schemes described in the post.
I’ll also take the opportunity to thank don and wolf for creating something actually worth reading and wish they and theirs all the best for the this new year and all future ones.
Let me see i I can simplify. Eurozone banks have issued and have outstanding multiple categories of bonds, with the following order of priority in their claims on the assets of the banks.
1. senior bonds (SB)
2. senior non-preferred bonds (SNP bonds)
3. contingent convertible bonds (COCO bonds)
COCO and SNP are subject to forced conversion into equity. That means that the bond issuer (the debtor) can force the bondholders (the creditors) to accept shares of stock (a.k.a. equity) in the issuer/debtor as payment for the bonds, under certain circumstances such as the issuer running out of capital. Shares are subject to stock-market valuations and may very well go to zero value.
Hence SNP and COCO are called “bail-in-able”, and they are subject to potential high losses of principal. A bondholder may never get their principal back.
The concern is that Italian banks are quietly (?) allowing their SB to mature without selling new SB as replacement, but instead trying to and perhaps succeeding in getting bond buyers to purchase SNP (or COCO) as replacements. And that SNP/COCO bond buyers may not be aware of the risk they are taking relative to the low interest rate they are getting in return.
“The concern is that Italian banks are quietly (?) allowing their SB to mature without selling new SB as replacement, but instead trying to and perhaps succeeding in getting bond buyers to purchase SNP (or COCO) as replacements. And that SNP/COCO bond buyers may not be aware of the risk they are taking relative to the low interest rate they are getting in return.”
Not just italian bank’s, the whole of france greece and club med are trying to work this hard along with any other unstable EU bank. they are watching what the italians get away with. The Mafia will love this. No state losses, much less pressure to seriously investigate, Fraudulent NPL’S.
The bail in rules make it clear that the State, is no longer the # 1 Backstop, hence Club Med banking need’s a new Backstop, One that it never has to repay and is very cheap.
The real fun will start when:
A the members of fund’s start exercising oversight on what is in the fund’s.
B there is constraint in the Club-med banking sector.
Leftists, and italians in particular, always want a way out of a financial problem, where somebody else pays.
The OPM Funds are the only buyers left, for these Garbage bond’s.
As somebody wrote the other day, the problem is, the Fraud’s the Bankers are perpetrating, are Legal.
Maybe a new acronym and terminology should be invented, namely FOCO bonds, for Force-Convertible bonds. People may find various suitable ways to pronounce FOCO, I can think of at least two myself :-).
I think Funded-Culture bonds are maybe better sounding, and as a last ditch measure maybe a Future-Keyed index could be used to increase temporary value perceptions.
Happy new year.