New bank rules distorting Europe's credit markets
Bonds sold by parent holding firms pose greater risk due to the potential losses if a lender fails
New rules that will govern the world's biggest banks are already distorting Europe's credit market at least five years before they take effect.
Senior bonds sold by Barclays and Royal Bank of Scotland Group yield as much as 39 basis points more than equivalent securities issued by the units they use to make loans. There was little difference in yields before this month.
The divergence underscores growing investor concern that senior bonds sold by parent holding companies could suffer losses if a bank fails, while debt of the operating companies will remain intact - a scenario regulators endorse. Investors are also anticipating a surge in issuance of senior debt that can be written down as lenders prepare for the biggest overhaul of financial debt in a generation.
"There's now greater risk in holding-company bonds and there's going to be greater supply," said Dan Lustig, a senior analyst at Legal & General Investment Management. "There's always a race between banks to prepare when regulations change and the market will discount everything immediately."
Regulators seeking to overcome weaknesses exposed by the financial crisis have forced lenders to bolster equity capital and limited the amount of liabilities they hold. Now they plan to make senior creditors responsible for losses at the world's biggest banks before they use taxpayer money to bail out failing lenders.
Issuing bonds through holding companies separates a lender's funding from its operations, making it easier to write down debt in a crisis, according to regulators at the Basel, Switzerland-based Financial Stability Board. They want banks to be able to continue to function even as debt is written off.
Lenders had about US$650 billion of loss-absorbing bonds outstanding in dollars, euros and yen, data showed. That amount might have to almost double to meet requirements by the stability board, HSBC Holdings chairman Douglas Flint said.
"Holding-company bonds are clearly easier to bail in and therefore they are riskier," said Filippo Alloatti, an analyst at Hermes Fund Managers. He said he expected increased issuance through holding companies.
Giles Edwards, an analyst at credit rating agency Standard & Poor's, said: "As a bondholder, where would you rather be? In the operating company or in the holding company where you're reliant on a stream of dividends that a regulator could interrupt? It's what's known as structural subordination."
In Europe, regulators in Britain and Switzerland have acted most decisively in splitting lenders into holding and operating companies. Banks in other countries, which have preferred to continue issuing out of operating companies, will have to come up with some form of bonds that can be written down.
"The authorities want a quick and easy solution they can carry out over a weekend if there's trouble," said Lustig at Legal & General. "If you've got different regulators in different jurisdictions, the process can drag out. A holding-company structure gets you round that."
