Financials Watch – European bank issuance outlook for 2018

by: Tom Kinmonth

  • 2018 will be another transition year for the bank debt issuance market
  • This follows 2017 which has seen a dramatic difference of GSIB vs. non-GSIBs
  • GSIB issuance should remain robust for the final TLAC preparation year
  • Non-GSIBs are in no hurry to issue the new style debt…
  • …a result of the the potential later date for European rules (MREL)
  • Senior Preferred issuance to linger, helped by three factors;
  • 1) Laws lacking 2) TLAC allowance 3) SNP issued now not 2022 MREL eligible
  • Overall, we estimate EUR 44bn of Tier 3 bank debt issuance in 2018…
  • and have a traditional senior expectation of EUR 21bn in 2018

DISCLAIMER: This report has not been prepared in accordance with the legal requirements designed to promote the independence of investment research, and that it is not subject to any prohibition on dealing ahead. This report is marketing communication and not investment research and is intended for professional and eligible clients only.

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Funding for 2018: Another transition year as TLAC preparation is finalised

2018 will be another transition year for European banks. Once again bank funding will be a product of the multitude of capital requirements and legal implementations that have arisen within the sector. Crucially, 2018 will be the last year that globally systemic important banks (GSIBs) have to comply with total loss-absorbing capacity (TLAC) rules that will be effective form 1 Jan 2019. The non-GSIB banks, the less globally significant banks, however, will have a different perspective on the year. The different capital regimes, dependent on the classification of bank, will impact the issuance of the new style of Tier 3 debt (HoldCo Senior and Senior Non-Preferred) versus traditional senior debt (OpCo Senior and Senior Preferred).

2017 Issuance: The gulf between GSIB and non-GSIB

On the surface the total issuance of euro denominated benchmark debt in 2017 has not varied regardless of the global classification of the bank. We have seen the globally systemic banks issue EUR 35bn of debt into the Bloomberg EUR Banking Index so far this year, while the number is roughly EUR 42bn for non-GSIBs. The total on-GSIB debt outstanding in the index is around 21% higher than GSIB debt, as such, the total amounts of debt issued this year fit in line with the index as a whole.

However, the most remarkable difference is the type of bonds that have been issued, and to the contrary, this was dependent on whether a bank was considered global systemically important. We have seen a metamorphosis to the newer Tier 3 style debt from the older traditional senior debt (OpCo Senior and Senior Preferred). Indeed, GSIB issuance in 2017 of the newer Tier 3 debt (Senior Non-Preferred and HoldCo Senior) powered ahead and reached EUR 25bn by the end of Q3 2017. For non-GSIBS the figure was just under half of this amount, a mere EUR 12bn. Furthermore, the situation for traditional senior was the total opposite. Here the non-GSIBs have led the way, issuing EUR 23bn versus a mere EUR 4bn for GSIBs, as shown below.

The Tier 3 trend to power ahead

We expect the greatly superior issuance amount of Tier 3 debt versus traditional senior debt for GSIBs to continue. The national champions will continue to issue strongly next year, with Banco Santander SA, BNP Paribas SA and UniCredit SpA likely to be the most active issuers. Senior Non-Preferred issuance just for these names alone for next year is likely to be roughly EUR 39bn across all currencies.

It is now just a matter of time before the non-GSIBs join the party. Over time non-GSIB issuance of traditional senior debt will decline and these banks too will transform their funding to incorporate the Tier 3 debt. However, it is the timing that will be the fascinating debate.

Timing: Non-GSIBs to continue to have more space to breath

Non-GSIBs do not need to comply for TLAC 2019 standards, therefore, they are simply not pressured to issue this new type of debt so rapidly. These institutions, which are not considered to be globally systemic, still do have a barrage of items to concentrate on; Basel changes, leverage and Supervisory Review and Evaluation Process (SREP). However, these requirements do not force for the immediate issuance of the new Tier 3 debt class.

Long-awaited MREL clarity should arrive, but no rush for issuance
However, one item that will awake the non-GSIBs is the long-awaited clarity by European authorities in regard to minimum requirement for own funds and eligible liabilities (MREL). MREL is essentially a European framework that goes beyond just the world’s largest institutions to set a capital framework for all the remaining main EU banks. Hence, any further details by the European authorities on MREL will significantly impact the European bank funding landscape for the future. It is on arrival of this clarity that the non-GSIBs can become aware of their future capital requirements, and how much Tier 3 debt they have to issue.

The requirements on MREL, as with TLAC, are setup to create more debt that can be bailed-in to protect the taxpayer. The requirement by authorities to have more debt segregated for authorities directly promotes the Tier 3 class. We expect that there will be at least a five year phase-in period within the eurozone for the EU banks to adjust to the new demands from regulators. Under a five year phase-in period the timeline would then be broadly in line with the UK and Sweden, which target 2022.

As we saw in our studies of the UK and Sweden, see here and here, upcoming redemptions of existing traditional senior debt can often supply the required amount of Tier 3 issuance to meet future capital requirements. Consequentially, the glut of Tier 3 issuance that we have seen for GSIBs to conform to TLAC, is not something that we expect to see under MREL. No doubt, issuance of Tier 3 debt will be vast as regulators set in stone their demands for the volume of segregated debt instruments needed. However, for the most part, issuance should not exceed a bank’s traditional senior redemptions over the next five years. Accordingly, simply replacing maturing traditional senior with Tier 3 debt will suffice to do the job.

Why are we seeing Senior Preferred debt still being issued?

This year, Senior Preferred debt has still been issued, even by GSIBs, and we think that Senior Preferred will undeniably still be issued next year also. We break down three of the main reasons;

1) Laws are still not in place for Senior Non-Preferred in some jurisdictions

Firstly, one stumbling block is that some countries do not have laws in place to issue a Tier 3 class. Some countries are still in the process of setting up the legal framework, such as Italy. While a number of counties also prefer to wait for full MREL guidance from the European authorities before transposing the judgments into national law. Countries such as Austria and the Netherlands are on this list. For that reason, banks in countries without the laws will continue to issue Senior Preferred debt in the meantime.

2) GSIB banks can still utilise Senior Preferred for capital requirements

The second point pertains to the GSIBs, and their capital requirements. Principally their TLAC requirements allow them to use traditional senior (OpCo Senior and Senior Preferred) issuance for their capital requirements, 2.5% in 2019 and 3.5% for 2022. As a result, these global banks are taking advantage of this benefit given by regulators, and are issuing the cheaper Senior Preferred class. In our next Financials Watch we will analyse the actual need banks will have for Senior Preferred in their funding mix once the capital regimes are applied.

3) Senior Non-Preferred issued now may not be eligible for 2022 MREL requirements

The third factor applies mainly for non-GSIB banks in regard to their timeframe. As they simply have longer to prepare this funding to meet future capital requirements. Even if a bank does issue Senior Non-Preferred debt in 2017, it may be not be eligible for MREL eligibility in 2022. The bond may have matured by this date, or the bond could be even be just approaching maturity to be ineligible. One guideline requires that instruments must have a remaining maturity of at least one year;

‘Debt with at least 12 months remaining on their terms that are subject to the bail-in power and those that qualify as own funds’

Bank Recovery and Resolution Directive (BRRD), Article 45, here

Consequentially, if you issue for example a five year bond now, it will not be eligible for capital requirements in 2022. As eurozone clarity is still lacking, banks are likely to await further guidance before committing their funding schedules to the new debt class.

Issuance expectations for 2018: Traditional senior to persist…at least for now

Bringing all of the above information together, we now set out our initial estimate for euro issuance for 2018. Our draft expectations estimate roughly EUR 21bn of euro traditional senior debt (Senior Preferred and OpCo Senior) to be issued into the Bloomberg Euro-Aggregated Banking Index next year. Although, we expect over double this for the Tier 3 type debt class, roughly EUR 44bn. France, Italy and the United Kingdom banks should be the main drivers in issuance of the new debt class.

Before the end of the year national and European authorities will give far more guidance. Therefore, we will update these estimates in our Financial Watch Outlook 2018 which we will publish towards the end of the year.