Senior bank debt issues slump to decade low as investors grow increasingly wary of being forced to take losses amid regulators’ demands for greater protection of taxpayers and depositors

June 16, 2013 6:00 pm

Senior bank debt issues slump to decade low

By Christopher Thompson

European banks’ issuance of senior debt has fallen to its lowest level in more than a decade as investors grow increasingly wary of being forced to take losses amid regulators’ demands for greater protection of taxpayers and depositors.

This year EU banks have issued $132bn in senior debt to date, down from $158bn over the same period last year and the lowest total since 2002, according to data compiled by Dealogic.

The decline in issuance partly reflects widespread concern among investors about EU “bail-in” rules – yet to be finalised – that aim to reduce the cost of bank bailouts for taxpayers by forcing losses on creditors. The rules are expected to favour bank depositors over holders of senior unsecured debt, exposing the latter to losses if a bank defaults.

Traditionally, senior unsecured debt holders have expected similar protection to depositors. That means they are among the first to be paid if a bank defaults in contrast to other unsecured or subordinated debt holders.

“Investors are much more conscious of relative value and risks,” said Daniel Bell, head of capital products for Europe, Middle East and Africa at Bank of America Merrill Lynch. “If there is a preference for depositors, then senior debt holders are effectively subordinated, so some are asking – am I getting paid for that?”

By contrast investors’ appetite for riskier but potentially more lucrative subordinated debt, which typically pays a higher interest rate, has increased.

Subordinated debt issuance has quadrupled from last year to $16bn, the highest year-to-date total since $73.7bn in 2008.

“[Bail-in] is at the forefront of our minds … it always comes down to the compensation for risk: how much extra yield do you get?” said Richard Ryan, senior credit fund manager at M&G Investments, which manages £147bn of fixed-income investments. “What we’ve observed is that the difference in yields between senior and subordinate debt has been contracting, which tells you that investors think if the bank goes pop the outcome is likely to be similar between those two.”

Senior debt issuance is less than half the $293bn banks issued to investors in 2011 as banks borrow less in order to bolster their balance sheets. Banks have also taken advantage of alternative funding sources such as the cheap loans on offer under the European Central Bank’s longer-term refinancing operations (LTRO).

Earlier this year bailouts of the Dutch bank SNS Reaal, Ireland’s Anglo Irish and banks in Cyprus raised concerns that the EU was reshuffling the credit hierarchy.

Melissa Smith, head of high-grade debt capital markets at JPMorgan, said recent bond market volatility had heightened investors’ worry about the risks of being bailed-in when banks fail.

“As the market starts to get more volatile and investor risk-appetite wanes, we expect people will be more focused on bail-in,” she said. “That’s one of the reasons why senior is expected to underperform because people will price in the risk of bail-in going forward.”

Last week Japan cleared it’s own bail-in legislation, which will force losses on holders of new types of preferred shares or subordinated bonds if regulators deem the issuer insolvent.

Analysts expect the EU to implement its harmonised rules for who gets what in the event of a bank failure by 2016.

Until then, uncertainty remains the order of the day.

“Uncertainty doesn’t help,” said Julia Hoggett, a managing director at Bank of America Merrill Lynch. “I think investors will hold off making too big a positioning until the final picture is clearer.”