Spain’s three biggest banks, Banco Santander, BBVA and Caixa Bank, have got off to a flying start this year having issued €8.6 billion in new debt, seven times the amount they sold during the same period of last year. The last time they rolled out so much debt so quickly was in 2007, the year that Spain’s spectacular real estate bubble reached its climactic peak.
Santander accounts for well over half of the new debt issued, with €5.12 billion of senior bonds, subordinate bonds, and a newfangled class of bail-in-able debt with the name of “senior non-preferred bonds” (A.K.A. senior junior, senior subordinated or Tier 3) that we covered in some detail just before Christmas.
This newfangled class of bail-in-able debt was cooked up last year by French-based financial engineers in order to help France’s four global systemically important banks (BNP Paribas, Crédit Agricole, Groupe BPCE and Société Générale) out of a serious quandary: how to satisfy pending European and global regulations demanding much larger capital and debt buffers without having to pay investors costly returns on the billions of euros of funds they lend them to do so.
That’s what makes senior non-preferred debt so ingenious: it pretends to be simultaneously one thing (senior), in order to keep the yield (and the cost for the bank) down, and another (junior) in order to qualify as bail-in-able. What it amounts to is a perfect scam for big banks to bamboozle bondholders – usually institutional investors like our beaten-down pension funds – into buying something with other people’s money that doesn’t yield nearly enough to compensate them for the risks they’re taking.
Put simply, if a bank is resolved, holders of these instruments could lose much or all of their money, similar to stock holders. According to Olivier Irisson, executive chief financial officer at Groupe BPCE, France’s second largest bank, it’s a “very good compromise for investors and banks.”
Judging by how they’re selling, yield-starved investors seem to agree. After the new bonds were rubber stamped by the Banque de France in mid-December, investors gobbled up €1.5 billion of Credit Agricole’s senior non-preferred 10-year bonds despite only receiving about 45 basis points more than they would get on traditional senior debt and about 65 basis points less than on subordinated.
Société Générale quickly followed CA’s lead, issuing €3.5 billion of 5-year dollar-denominated notes. Investors lapped it up. During the same week BNP Paribas sold €1 billion of bail-in-able debt, a mere drop in the ocean compared to the €30 billion of senior non-preferred debt it hopes to raise by 2019. BPCE issued its first non-preferred deal in the second week of the year, a €1 billion six-year trade that attracted $2.4 billion of orders. It then launched an even riskier samurai (yen denominated) non-preferred trade, and most investors were not put off by the A- rating.
“2017 will be the year of senior non-preferred,” said Vincent Hoarau, head of financial institutions syndicate at Crédit Agricole. Europe’s biggest banks certainly have a voracious appetite for new funds. The European Banking Authority recently estimated a €310 billion gap in all the region’s banks meeting their total loss absorbing capital requirements before the 2019 deadline. And much of that gap is expected to be filled by senior non-preferred bonds.
The European Commission has already endorsed the financial instrument, rating agencies have also lent their approval and the ECB can’t wait to come up with “a common framework at Union level“. However, the legislation permitting its issuance is currently only in place in France and is not expected to be passed elsewhere in Europe before the second half of 2017, at the earliest.
But certain banks have already jumped the gun, including Holland’s ING and Spain’s Santander, both of which have begun issuing senior non-preferred bonds despite the fact their issuance has not been officially sanctioned by each bank’s respective national regulator. Even more ominous, Italy’s fragile superbank, Unicredit, has also expressed an interest, though it will probably have to wait for Italy’s banking crisis, of which it has a major part, to blow over (assuming it can) before joining the party.
A Staggering Volume of Debt
Even by today’s inflated standards, the volume of debt the G-SIBs hope to issue in the next two years is staggering. Santander alone intends to issue between €43 billion and €57 billion, in order to meet the capital requirements that are scheduled to come into effect for the world’s 30 biggest banks on Jan 1, 2019. That’s between 60% and 75% of Santander’s entire market cap. And if everything goes according to plan, most of that debt — between €28 billion and €35.5 billion worth — will be issued in the form of senior non-preferred bonds.
For the moment there’s little concern over investor appetite, says Demetrio Salorio, global head of debt capital markets at Société Générale Corporate & Investment Banking. “The investor base is keen,” he says. “They are far more at ease with the instrument than they were 18 months ago.” Spreads could even tighten, he reckons.
All of which is testament to just how desperately starved of yield institutional investors have become in the NIRP environment as they’re trying to get their hands on financial instruments that offer virtually no security in exchange for the slimmest of additional returns.
But the investor pain, when it’s time for it, should relieve taxpayers and the public. When the bank collapses and is being resolved or recapitalized, these bondholders are supposed to get bailed in and lose some or all of their investment. This would protect taxpayers at least to some extent from getting shanghaied into doing that job. And if institutional investors who take that risk don’t get paid enough for taking that risk, so be it. It’s just pension funds and retirement nest eggs under their management that will take the hit.
Unless, of course, the government, under political pressure, decides to bail out those bondholders anyway with taxpayer money, as they’re doing in Italy’s banking crisis at the moment, on the pretext that these bondholders were naive retail investors who were missold a similar version of bail-in-able junior bonds. And so it would be back to square one.
In Italy, the insider blame game has begun. Read… Italy’s Banking Crisis Is Even Worse Than We Thought