To see how byzantine bank capital rules have become, you only have to look at a new kind of bond being issued by French banks: the senior, non-preferred Tier 3 security.
It's an ugly name for a bond, and a contradiction in terms. In the capital markets, you're either senior -- having first claim on the borrower's assets -- or you're down the pecking order.
But that's decreasingly the case for banks these days. As European regulators have sought to make failed lenders safer to defuse, protecting depositors and so on, they have pushed even senior bondholders down the queue. They're still first, but among equals.
The result? European banks have reduced their sales of traditional senior debt. But such debt forms a crucial part of the way banks fund their business.
Credit Agricole SA has jumped fast to plug a hole in its capital structure, taking advantage of French legislation only passed over the weekend that allows them sell this new slice of debt. After receiving orders for 5 billion euros ($5.3 billion), it sold 1.5 billion euros ($1.6 billion) of the 10-year bonds. Societe Generale SA is now readying its own five-year offering and BNP Paribas SA is poised to follow.
But it's not clear these securities will be a long-term success. And investors have to work out the fair price of a security that isn't quite senior, but isn't quite subordinated.
Blame the new Basel III Total Loss Absorbing Capacity requirements for global systemically important banks from the Financial Stability Board.
Under these rules, senior unsecured bonds will remain at the top of the fixed-income pile. They won't be part of a bank's total loss absorbing capacity and won't be subject to the new bail-in rules. (In Credit Agricole's case, they're rated A1 by Moody's.)
Senior non-preferred bonds will slot below. They will be subject to the bail-in rules. (Agricole's are rated Baa2e by Moody's.) Next come Lower Tier II bonds. Agricole's have a Baa2 rating from Moody's.
It's clear in ratings terms, then, the senior non-preferred bonds are closer to lower Tier two than senior preferred. It makes little sense to price them off existing senior debt.
Credit Agricole is only paying about 45 basis points more to issue senior non-preferred bonds than it would to sell traditional senior debt and about 65 basis points less than it would for subordinated.
That doesn't look like a generous premium for a security that comes with its own mystery: how can investors consider a bond that can be bailed in as truly senior?
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