“We’re spending hours and hours on this every day,” one senior banker tells Euromoney. ‘We’re at the point of LAC fatigue.”
But for one group, the fun is only just beginning. The FIG debt capital markets bankers who serve their own treasuries and those of other banks as issuers are rubbing their hands in glee. There’s been too little innovation in recent years as regulators and customers have insisted on simplification of financial products and greater transparency. TLAC is a god-given chance for investment bankers to do what they do best: devise complicated new instruments.
Bankers on the cutting edge are already moving beyond the sterile debate over how far spreads on bank holding company senior unsecured debt should exceed spreads on operating company senior. (Quite far Euromoney would venture). They are now devising new classes of contractually subordinated debt instruments. These come in two types. Senior subordinated notes (SSNs) should rank above Tier 2 debt in the capital structure, but below senior unsecured debt. One step up from senior subordinated should come Priority Bail-in Notes (PBNs). These might rank pari passu alongside senior unsecured debt in the creditor hierarchy to be paid out in an insolvency but below senior unsecured – though above SSNs – in a bail-in.
|Mark Carney, FSB chairman|
Photo by James Oxley, Bank of England
Discussions between FIG investment bankers and potential bank issuers on how these instruments might work were gathering pace even before the TLAC proposals were published last November. By the end of last year FIG bankers were saying these were close to bearing fruit.
They hope that these new notes might price at a discount to standard issues of Tier 2 debt by perhaps 50-60 basis points, partly because they will be short-dated, partly because they might attract a wider universe of buyers than Tier 2. TLAC eligibility only requires senior bail-in-able debt to have a maturity greater than one year and so the hope is that a market might emerge in which to roll over these new instruments with maturities just over 12 months.
While some debt investors have mandate restrictions preventing them from buying bank capital instruments up to and including Tier 2, the debt market wizards hope to entice some of those by branding the new notes as senior debt.
It’s at this point that Euromoney starts to feel a chill. Isn’t that rather against the spirit of the times? Senior subordinated notes: are they senior, or are they subordinated? Can they be both at the same time? Euromoney hears a faint echo of the years after the S&L crisis when US banks briefly devised a whole new category of loans that had enjoyed forbearance but on which borrowers were now meeting restructured terms. These were called performing non-performing loans.
Savings in the tens of basis points on these new instruments – let’s call them Tier 3 – compared to Tier 2 might come in very welcome for bank issuers. Some estimates for the universe of large European banks put the total gap to minimum TLAC requirements (excluding currently issued senior debt) in the range of €400 billion-€500 billion.
Investment bankers thrive on innovation and complexity – that’s where the money is – and one can forgive them for being so excited by the chance to create whole new classes of instruments. But what’s most striking about these plans is that they are exactly what banks’ other big customers – institutional investors – say they don’t want.
In late November and early December last year Nomura surveyed 116 investors, including asset managers, hedge funds and insurance companies, mainly in Europe but also in the US and Asia, many with over $50 billion in assets under management each. It asked investors what they would advise bank issuers to do about TLAC.
The response was clear. Banks’ capital stack is already complex enough. Don’t bring new classes of instrument into it. Be clear about your target capital structure. Start issuing senior debt out of a holding company, if you have one, as soon as you can and otherwise concentrate on Tier 2 debt. Look to refinance non-TLAC compliant funding with these instruments – whose eligibility is uncontested – as it rolls off.
So as one investor advises bank issuers to “get on with T2 OpCo and HoldCo issuance without any unnecessary funky/nasty/weird language”, and another says, “No Tier 3 notes please”, the investment bankers press on with crafting the legal documentation for Tier 3.
Bless the investment bankers. They can’t change their spots.