Bank Subordinated Debt May Rally Before Basel Makes It Extinct, RBC Says

Bank subordinated securities that regulators are proposing to phase out will probably rise as they become scarcer and issuers buy them back, according to Hank Calenti, an analyst at Royal Bank of Canada.

Under proposals put forward by the Basel Committee on Banking Supervision, the so-called upper Tier 2 bonds that banks use as a cushion against losses will probably be reorganized as a single category with cheaper-to-issue lower Tier 2 notes, London-based Calenti said in a report.

“These securities will become less useful from a capital perspective and they’re expensive, so banks will have an incentive to call them back,” Calenti said in a telephone interview. “That and scarcity should push spreads tighter.”

Regulators are looking for ways of ensuring taxpayers won’t be called on to bail out banks again, focusing on the quality of the capital they hold. A series of recommendations will probably be published toward the end of the second quarter, according to Calenti.

Supervisors want banks to hold mainly equity to absorb losses while their businesses are still going concerns. Lower Tier 2 debt would be used to buffer losses to depositors and senior bond holders when a company collapses and is liquidated.

Upper Tier 2 debt has returned 7.54 percent this year, compared with 11.87 percent for more-junior Tier 1 securities, according to Bank of America Merrill Lynch index data. Banks’ senior bonds have returned 2.96 percent, the data show.

To contact the reporter on this story: John Glover in London at johnglover@bloomberg.net