Bank Credit

November 27th, 2014 11:21 pm | by John Jansen |

This is an informative and interesting article in the tiering of bank credit. This time the tiering is intra firm as holding company bonds cheapen to bonds issued by the operating entity of the same bank.

Via Bloomberg:

Bank Holding Company Bonds Fray as Traders Fret Over Risk

By John Glover Nov 27, 2014 5:50 AM ET

New rules that will govern the world’s biggest banks are already distorting Europe’s credit market at least five years before they take effect.

Senior bonds sold by Barclays Plc and Royal Bank of Scotland Group Plc yield as much as 38 basis points more than equivalent securities issued by the units they use to make loans. There was little difference in yields before this month.

The divergence underscores growing investor concern that senior bonds sold by parent holding companies could suffer losses if a bank fails, while debt of the operating companies will remain intact — a scenario regulators endorse. Investors are also anticipating a surge in issuance of senior debt that can be written down as lenders prepare for the biggest overhaul of financial debt in a generation.

“There’s now greater risk in holding-company bonds and there’s going to be greater supply,” said Dan Lustig, who helps oversee about $745 billion as a senior analyst at Legal & General Investment Management in London. “There’s always a race between banks to prepare when regulations change and the market will discount everything immediately.”

Regulators seeking to overcome weaknesses exposed by the financial crisis have forced lenders to bolster equity capital and limited the amount of liabilities they hold. Now they plan to make senior creditors responsible for losses at the world’s biggest banks before they use taxpayer money to bail out failing lenders.

Funding Separated

Issuing bonds through holding companies separates a lender’s funding from its operations, making it easier to write down debt in a crisis, according to regulators at the Basel, Switzerland-based Financial Stability Board. They want banks to be able to continue to function even as debt is written off.

Lenders have about $650 billion of loss-absorbing bonds outstanding in dollars, euros and yen, according to data compiled by Bloomberg. That amount may have to almost double to meet FSB requirements, HSBC Holdings Plc Chairman Douglas Flint told a Nov. 19 conference in Brussels.

The FSB’s proposals affect 30 banks tagged as the largest and most important in the world. In Europe, these include RBS and Barclays, as well as HSBC Holdings Plc and the biggest banks in France, Germany and Spain.

Emerging Markets

In Asia and the U.S., banks typically have holding companies, though these don’t necessarily meet all the FSB’s requirements, according to Emil Petrov, head of capital solutions at Nomura International Plc in London. The FSB exempted banks based in emerging markets, a measure that affects only Chinese institutions.

“Holding company bonds are clearly easier to bail in and therefore they are riskier,” said Filippo Alloatti, who helps oversee about $44 billion as an analyst at Hermes Fund Managers Ltd. in London. He said he expects increased issuance through holding companies.

Investors are taking note of both the risk and the likely supply. RBS’s 2 billion euros ($2.5 billion) of 5.375 percent notes due September 2019, issued by its banking unit, now yield about 0.84 percent, data compiled by Bloomberg show. The same lender’s 1 billion euros of 1.625 percent bonds maturing in June 2019 and sold by its holding company yield 38 basis points more at 1.22 percent. Until this month, the gap averaged 4.5 basis points.

Barclays Bonds

The 1 billion euros of 1.5 percent bonds maturing in April 2022 that London-based Barclays sold from its holding company were yielding an average of 36 basis points more than the 2.125 percent bonds due February 2021 sold by Barclays Bank up until the end of October. Since then, the gap jumped to 60 basis points, as the yield on the holding company bonds surged.

The extra risk hasn’t escaped the ratings firms. Bonds of Barclays Plc (BARC), the holding company, are graded A- at Standard & Poor’s and an equivalent A3 at Moody’s Investors Service. Notes sold by its bank are rated a step higher.

“As a bondholder, where would you rather be?” said Giles Edwards, an analyst at S&P in London. “In the operating company or in the holding company where you’re reliant on a stream of dividends that a regulator could interrupt? It’s what’s known as structural subordination.”

In Europe, regulators in the U.K. and Switzerland have acted most decisively in splitting lenders into holding and operating companies. Banks in other nations, which have preferred to continue issuing out of operating companies, will have to come up with some form of bonds that can be written down.

‘New Layer’

These include issuing new capital securities, or “a new layer” of senior debt that would count toward the lender’s total loss absorbing capacity requirement, according to Barclays analysts.

S&P this week told investors it will probably remove any assumption of government support when assigning senior ratings to bank holding companies, meaning these bonds may be downgraded because of the risk of being bailed in.

“The authorities want a quick and easy solution they can carry out over a weekend if there’s trouble,” said Lustig at Legal & General. “If you’ve got different regulators in different jurisdictions the process can drag out. A holding company structure gets you round that.”

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