S&P: Bail-in debt remodels risk profile of bank funding In Europe and North America
Despite the strengthening of banks in North America and Europe since the great recession, the risk profile of their wholesale debt has increased as they skew their term issuance toward bail-in instruments, S&P Global Ratings noted in a report published today. Traditional operating company senior debt is predominantly an asset class that has ratings in the ‘A’ category for major issuers, but nearly 40% of the outstanding unsecured bank debt in North America and Europe is rated in the ‘BBB’ category, up from just above 25% four years ago, as loss-absorbing instruments account for a growing share of funding.
While nonoperating holding company (NOHC) senior debt remains the largest bail-in asset class in aggregate in these two regions, senior subordinated debt (also known as senior nonpreferred and senior resolution notes) is growing fast and now totals nearly $300bn.
Across the Group of 20 and beyond, regulators and policymakers united following the global financial crisis in their desire to address “too big to fail.” This led to the publication by the Financial Stability Board of its total loss-absorbing capacity (TLAC) standards in November 2015, and other related national or regional regulations followed. These new rules have underpinned the emergence of senior subordinated instruments in Europe (known as senior nonpreferred) and–more recently–Canada. They have also clarified the loss-absorbing role of some existing instruments such as the nonoperating holding company (NOHC) senior debt of systemic banks in North America and Europe.
Regulations intend these loss-absorbing instruments to reduce the possible need for extraordinary government support if a systemically important bank fails. In such a scenario, the holder of the loss absorbing debt may be bailed-in (that is, their debt or a portion of their debt will be written down or converted to equity to recapitalise the insolvent bank).
We reflect these regulatory developments in our rating approach for these instruments. We typically rate the traditional operating company (opco) senior unsecured debt of banks in the U.S., Canada, and Europe higher than senior NOHC and senior nonpreferred debt. This is due to the explicit loss-absorbing nature of senior NOHC and senior nonpreferred debt in a resolution scenario; indeed, the bail-in of these junior liabilities bolsters the capacity of a bank to pay its senior creditors on time and in full.
As a result, most of North American and European bank NOHC and senior nonpreferred debt is concentrated around the ‘A-‘ and ‘BBB+’ levels, while most rated traditional senior opco debt is concentrated around the ‘A+’ rating level, therefore an average gap of two to three-notches.
While new U.S. bail-in debt issuance (out of NOHCs) will likely mostly focus on refinancing, we expect further growth in the issuance of bail-in debt in Europe and Canada, whether senior NOHC debt or opco senior subordinated. In Europe, the pace of growth may be restrained by relatively prolonged implementation horizons for resolution regulations (such as those on minimum requirements for own funds and eligible liabilities or MREL) and the fact that some banks with small extra requirements are likely to simply top–up existing buffers of tier 2 capital, among other factors.