BNP Senior Debt Deal Shows Legal Muddle Facing EU Bond Investors

  • France, Germany take different approach to implementing BRRD
  • EU countries are diverging on how to impose write-downs

BNP Paribas SA sold senior bonds last week at the same premium it paid two years earlier, even though new European Union rules had in theory just made them riskier. Its German rivals may not be so lucky when they come back to the market.

France and Germany are implementing the Bank Recovery and Resolution Directive, which came into force on Jan. 1. The measure is intended to take taxpayers off the hook and end the protection for some bondholders should a bank fail. But the two countries are doing it differently, part of a patchwork of approaches across the 28-member EU that highlights the latest challenge to investors in bank debt.

The French government plans to offer a layer of protection for investors in traditional senior notes by introducing a new category of “non-preferred” senior bonds that would be written down or converted to equity. In Germany, a new law exposes all senior unsecured debt to loss starting in 2017.

“Under the BRRD, all of a bank’s senior bonds can be bailed in,” said Steve Hussey, an analyst at AllianceBernstein in London. “The issue is the order in which that happens. On that there’s a near-complete lack of agreement across Europe.”

Largely Unscathed

Outside of bankruptcy courts, where Lehman Brothers Holdings Inc. and the Icelandic banks ended up, senior bondholders made it through the financial crisis largely unscathed. Ireland took a bailout rather than let its banks default on senior debt.

While the BRRD makes all of a collapsed bank’s creditors pay for the cleanup, it’s been left to national authorities to make the measure gel with their insolvency frameworks. The order of claims by creditors is vital to debt investors because those most likely to suffer losses charge for taking the extra risk.

Investors who lent to BNP last week will receive 1.125 percent a year for seven years, and in return expect to get their money back in full. That compares with the 7.375 percent coupon on the bank’s undated junior subordinated bonds in dollars that, in the worst case, could be left worthless without penalty to the issuer. Today the new senior bond was trading at 99.53 cents on the euro, down from its issue price of 99.586 cents, data compiled by Bloomberg show.

Charts yield of the bond
Charts yield of the bond

Three approaches to setting the new order of losses are emerging in the EU:
enshrining the subordination of creditors in law, in contracts or in corporate structure.

Big U.K. and Swiss banks typically have non-operational holding companies they can use to issue debt, which has allowed lenders including Barclays Plc and UBS AG to begin issuing bonds that bail in those investors in the event of failure. Barclays has begun buying back its operating company’s bonds to replace them with holding company’s debt.

Tender premium on operating company bonds sinks yield relative to parent bonds
Tender premium on operating company bonds sinks yield relative to parent bonds

In the euro region, Germany led the way by changing its law to expose senior bonds to a writedown before Italy followed suit.

Italian banks have a history of selling senior bonds to individuals, so preference for depositors only comes into force from the start of 2019, when most securities held by retail investors should either have matured or been excluded. The practice of selling to retail investors “blurs the line” between a government’s responsibility to protect individuals and “the need to implement BRRD,” Fitch Ratings said in a note.

French Rule

In France, the documents for a bank bond preclude the insertion of a new category of subordinated debt ahead of existing Tier 2 securities, according to Christy Hajiloizou, an analyst at Barclays in London. So the Finance Ministry is proposing a new category of senior bonds instead.

“Non-preferred could have been introduced as a way to get around the contractual Tier 2 issue,” said Hajiloizou.

The new layer of bonds will potentially help support an issuer’s rating and will probably be eligible for inclusion in the total loss absorbing capacity the world’s biggest banks must have available, Standard & Poor’s said in a report.

Spain has similar problems to France. It still isn’t clear whether bond prospectuses permit the issuance of different layers of subordinated debt with varying ranks even after the nation amended its insolvency laws last year, according to Hajiloizou.

“For the rest, we just don’t know,” said Simon Adamson, an analyst at CreditSights Inc. in London. “They all seem to be waiting to see what everyone else does. Whatever they do, it’s going to be confusing for non-EU investors because they’re going to have three different systems to deal with.”

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