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Sancho Panza

European Banks Dump Massive Amounts Of Subordinated Debt On Investors

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Mish 19/12/13

' Big rise in subordinated debt issuance by EU banks

Banks have taken advantage of yield-chasing investors to issue $90.7bn of subordinated debt for the year to date, a 41 per cent increase compared to the same period in 2012
. It is the highest such volume since the $122.4bn seen in 2008 according to Dealogic, the data provider.
The figures follow a deal agreed by European regulators earlier this month that will bring in so-called bail-in rules for senior bondholders from 2016, two years earlier than envisaged by finance ministers in their common position agreed in June.
Banks are also expected to issue record amounts of loss-absorbing contingent convertible
– or "coco" – bonds next year, which can either convert to equity or wipe out investors entirely if a bank's capital ratio falls below a pre-agreed level.

Junior Bonds

An apt description for "subordinated debt" is "junior bonds". From Wikipedia ...

  • Subordinated debt (also known as subordinated loan, subordinated bond, subordinated debenture or junior debt) is debt which ranks after other debts should a company fall into liquidation or bankruptcy.
  • Subordinated debt has a lower priority than other bonds of the issuer in case of liquidation during bankruptcy, and ranks below the liquidator, government tax authorities and senior debt holders in the hierarchy of creditors.
  • Subordinated debt is issued periodically by most large banking corporations in the U.S. Subordinated debt can be expected to be especially risk-sensitive because subordinated debt holders have claims on bank assets only after senior debt holders. Subordinated debt holders also lack the upside gain enjoyed by shareholders.
  • Consider asset-backed securities. These are often issued in tranches. The senior tranches get paid back first; the subordinated tranches later. Mezzanine debt is another example of subordinated debt.
  • Subordinated bonds are regularly issued as part of the securitization of debt, such as in the issue of asset-backed securities, collateralized mortgage obligations or collateralized debt obligations.
  • Corporate issuers tend to prefer not to issue subordinated bonds because of the higher interest rate required to compensate for the higher risk, but may be forced to do so if indentures on earlier issues mandate their status as senior bonds.

Now that we know what subordinated debt is, it's easy to understand the increase in issuance. It relates to bail-in procedures in the alleged European "banking union".'

'If you can't see the mark'

Edited by Sancho Panza

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The Financial Policy Committee want to see a lot more securitization.

The director for financial stability at the Bank of England, Andy Haldane, said the BoE wants to throw its weight behind the use of securitisations in boosting flows of credit to small businesses, the Financial Times reported on Tuesday.

Haldane, a senior policymaker on the Financial Policy Committee, said bundled debt in Britain need not be the "bogeyman" it was during the financial crash and that it could play a role in small- and medium-sized enterprise lending and other areas including student loans, the newspaper said on its website.

Securitisation, in which banks bundle pools of loans and sell the resulting package to raise funds for lending, was discredited in 2007 when underlying mortgages defaulted, triggering the global financial crisis, which resulted in banks having to be rescued by taxpayers.

Now, however, the securitisation market is seen as a valuable option for financing business growth.

The Financial Policy Committee said in November that it may step in to kick start the securitisation market, aiming to develop approaches to promote a better functioning securitisation market in the UK.

The European Central Bank is also keen to see a revival, while European Investment Bank experts say small- and medium-sized enterprises and young innovative firms now need to tap securitisation and venture capital to expand and prosper.

http://uk.news.yahoo.com/boe-policymaker-securitisation-could-boost-224224708.html

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Think the reasons for this are twofold.

QE has reduced yields across the board (as intended) creating a search for yield/pushing investors into risky assets (as intended). Banks are responding to this by issuing sub paper as the demand there means they get to issue at attractive rates.

The second reason is the changing regulatory environment. Ball III and CRD IV have rendered a lot of existing tier 1 capital (sub debt) obsolete, as it didn't meet new requirements for that classification. Banks have responded by issuing cocos. I think current Coco issuance maybe $60bn and Barclays suggested, based upon current paper that would need replacing along with increased capital requirements, this market could grow to 400bn.

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Think the reasons for this are twofold.

QE has reduced yields across the board (as intended) creating a search for yield/pushing investors into risky assets (as intended). Banks are responding to this by issuing sub paper as the demand there means they get to issue at attractive rates.

The second reason is the changing regulatory environment. Ball III and CRD IV have rendered a lot of existing tier 1 capital (sub debt) obsolete, as it didn't meet new requirements for that classification. Banks have responded by issuing cocos. I think current Coco issuance maybe $60bn and Barclays suggested, based upon current paper that would need replacing along with increased capital requirements, this market could grow to 400bn.

It makes perfect sense for banks to issue out these bonds at these rates.

Ergo,I'm not so sure it makes sense to buy them-although everyone has their reasons.

On a separate note Terry,can you explain in laymans terms how sub debt sat on a balance sheet as tier one capital and can you also explain how the changes in Basel III forced the banks into issuing coco's.It's a grey area for me.

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It makes perfect sense for banks to issue out these bonds at these rates.

Ergo,I'm not so sure it makes sense to buy them-although everyone has their reasons.

On a separate note Terry,can you explain in laymans terms how sub debt sat on a balance sheet as tier one capital and can you also explain how the changes in Basel III forced the banks into issuing coco's.It's a grey area for me.

Qe has supressed returns so much that people will chase yield anywhere at the minute. Qe has been very successful in forcing people into riskier assets. Also, sub debt still has the protection of all the bank equity plus any AT1 (additional tourer 1, so continent capital ie stuff that becomes capital ie Cocos). In these days of increased bank capital this might mean a 15% cushion before you took a loss. Plus half these banks probably too big to fail. So it's not necessarily that risky. Just looking now Credit Suisse Sub 5yr CDS is 95bps, obviously this reflects QE reduced levels but that is definitely not considered risky. This is not to say some small Portuguese bank sub debt isn't dodgy, but I imagine most issuance from bigger banks.

Regarding basel II I'm no expert but I believe you now have common tier 1 and additional tier 1. Common is basically equity and the additional has loads of clauses. I think the killer clauses for old style tier 1 are no step ups (increase in coupon after a period, an incentive for issuer to redeem and common on old tier 1) and all coupons/dividends are fully discretionary with non payment not an event of default. Basically all the clauses push towards equity like not debt like instruments, whereas old tier 1 more debt like.

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they make up a lot of old shite for people to get excited about....dont they.

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Qe has supressed returns so much that people will chase yield anywhere at the minute. Qe has been very successful in forcing people into riskier assets. Also, sub debt still has the protection of all the bank equity plus any AT1 (additional tourer 1, so continent capital ie stuff that becomes capital ie Cocos). In these days of increased bank capital this might mean a 15% cushion before you took a loss. Plus half these banks probably too big to fail. So it's not necessarily that risky. Just looking now Credit Suisse Sub 5yr CDS is 95bps, obviously this reflects QE reduced levels but that is definitely not considered risky. This is not to say some small Portuguese bank sub debt isn't dodgy, but I imagine most issuance from bigger banks.

I've just reread the Mish piece and you're right,in terms of priority in the event of a collapse,these Coco holders step into the equity-if there's anything left.

Banks are also expected to issue record amounts of loss-absorbing contingent convertible – or “coco” – bonds next year, which can either convert to equity or wipe out investors entirely if a bank’s capital ratio falls below a pre-agreed level.

Read more at http://globaleconomicanalysis.blogspot.com/#RTOHTLOLajT5Ckxg.99

Regarding basel II I'm no expert but I believe you now have common tier 1 and additional tier 1. Common is basically equity and the additional has loads of clauses. I think the killer clauses for old style tier 1 are no step ups (increase in coupon after a period, an incentive for issuer to redeem and common on old tier 1) and all coupons/dividends are fully discretionary with non payment not an event of default. Basically all the clauses push towards equity like not debt like instruments, whereas old tier 1 more debt like.

Reading between the lines additional is tier one plus sub debt ie equity capital,retained profits,revaluation reserves plus sub debt ie what was the total capital ratio.The move towards equity like as you put it reflects the broader move towards bail ins.

Thanks for explaining that.

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Clear response from terry.

Banks do not really want to have to issue this stuff- it's too expensive compared to senior debt e.g. Barclays are paying more than 8% for its recent coco issue. However they are the easiest to bail in and that is what regulators care about these days.

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