by Don Quijones, Wolf Street:
To cover a capital shortfall of €50 billion.
New language can often serve as a cryptic signpost to the future. This is particularly true in finance. Take the expression “Too Big to Fail.” Within months of the fall of Lehman Brothers, the expression was being used so widely that it ended up being abbreviated to the now instantly recognizable TBTF.
For the captains of the global financial industry in their plush seats on the Basel-based Financial Stability Board, a TBTF bank was too simple and vulgar an iteration, so they coined a new term with a little more gravitas: Global Systemically Important Bank (or G-SIB).
Now a new word is coming into common use: “bailinable” (bail-in-able).
Bailinable debt consists of hybrid debt securities that automatically convert into equity and/or have their face value mercilessly slashed if some pre-defined trigger is met (usually linked to the issuer’s capital). It includes subordinated debt and high-risk instruments like the contingent convertible (CoCo) bonds that are designed to be bailed in first when a bank gets in trouble. Deutsche Bank’s CoCos famously crashed earlier this year, as did many other bank CoCos, but they’re once again in vogue.
Bailinable debt comes into play when a bank is about to go belly up. Part or all of the debt can be used to “bail in” a bank before taxpayers are called upon to cough up the rest. By providing additional resources when needed, bailinable debt should reduce the need for publicly funded bailouts in the resolution of bankrupt banks.
It’s the way it should have been from the very inception of this global banking crisis. Instead, governments and central banks have injected trillions of dollars, euros, pounds, yen, and yuan of public funds into banks’ hole-riddled balance sheets, while most bondholders have been made whole, including those holding subordinated, or junior, debt, which is theoretically designed to bear losses in times of stress.
Now, thanks to regulatory changes at the European and global level, some bondholders may have to finally begin paying the price of risk. But it’s unlikely to be senior bondholders. According to the Basel III Total Loss Absorbing Capacity requirements for global systemically important banks (yeah, them again), set by the Financial Stability Board, senior unsecured bonds will remain at the top of the fixed-income pile. That means they won’t be part of a bank’s total loss absorbing capacity and won’t be subject to the new bail-in rules.
That’s reassuring news for senior bondholders, but it’s not such good news for the TBTF banks that are facing regulatory pressure to issue increasingly more bailinable debt. Investors don’t like this kind of debt and demand higher yields. So this debt is expensive for banks. But as the pressure rises, we are likely to see a surge in issuance of riskier and presumably higher-yielding, and therefore costlier bank debt.
But France has figured out a way to pull a bag over investors’ heads with its newfangled class of bailinable debt – or rather a newfangled name for it.
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