Meddle With European Banks' Senior Bonds at Your Peril
(Bloomberg Gadfly) -- European regulators are breaking something that didn't need fixing. By pushing banks to issue senior non-preferred debt instead of traditional senior bonds, they risk inadvertently shutting many of the region's neediest lenders out of the funding market.
The securities are senior in name only -- they can be turned into equity in the event of a catastrophe in the same way as junior debt. With the collapse of Banco Popular Espanol SA fresh in investors' minds, weaker lenders are struggling to find buyers for what should be the most basic form of bond funding. Banks in the euro area have issued just 19 billion euros ($23 billion) of senior non-preferreds this year -- less than a third of what they sold in preferred senior debt in 2015. Regulators may need to rethink.
Senior non-preferreds, also called Tier 3 debt, sit above subordinated tier 1 and tier 2 in a bank's capital hierarchy. They rank below a bank's operating liabilities, putting them in the firing line once equity and subordinated capital are exhausted.
That ticks the right boxes for regulators trying to safeguard taxpayers from the costs of any bank failure. But for any new asset class to be a success it needs to function for investors and issuers as well. At the moment there is something of an impasse, where banks without investment-grade ratings are finding it tougher and more expensive to raise funds.
Thursday's senior non-preferred deal from Unione di Banche Italiane SpA is a case in point. It's only the second Italian bank to brave the new market, following UniCredit SpA's January offering. And as the lowest-rated entity to issue SNPs, it's an important test of investor demand.
While UBI's senior rating is just above investment grade, it has a split personality when it comes to SNPs: Fitch Ratings has the same BBB- rating, but the grade at Moody's Investors Service is three steps lower at Ba3. That clearly put some investors off.
Despite holding a full investor roadshow for a benchmark transaction, UBI was only able to unearth sufficient demand for a 500 million-euro ($613 million) deal. With more than 15 billion euros of debt maturing by the end of next year, the bank may question whether it was worth the effort. While the order book did finally reach 1 billion euros, the bank paid 80 basis points more than for its preferred senior bonds, offering a spread over mid-swaps of 140 basis points.
While French banks with solid investment grade credit ratings have been able to issue SNPs successfully -- paying on average an extra 25 to 30 basis points more than their traditional five-year preferred senior debt -- the market isn't proving to be as accessible or cost-effective for their Italian counterparts, which are having to offer three times that premium. The same will be true for other mid-tier domestically-focused EU banks with weaker credit ratings.
Changing the rules of the game for senior funding blurred the line between what is regulatory required bank capital, that can be easily bailed-in, and what is a straightforward source of funding. Conflating the two exposes senior debt investors to a whole new level of risk, and makes it harder and more expensive for lower-rated banks to readily access a vital source of liquidity.
That's not healthy for the EU banking system. If left unresolved, shutting some banks out of the market for senior secured funding, it could even contribute to another banking crisis.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.
To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net.
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