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.