Bond-Market Darlings Falter as Riskiest Bank Debt Joins Selloffby
Notes suffer losses after two years of market-leading returns
Banco Popular, UniCredit bonds lead slump on rule change
Europe’s riskiest bank debt has lost its immunity to strains in financial markets.
The notes, which have beaten corporate debt for two years, are getting dragged into a global selloff of risky assets because tighter capital regulations have increased the chances of bondholders not getting coupon payments. Yields also no longer dwarf those available from euro-denominated corporate junk bonds.
“It’s getting more difficult to be enthusiastic about European banking when regulators keep making life harder,” said Bill Blain, a strategist at brokerage Mint Partners in London. “The brutal truth is that European banking remains very badly damaged.”
So-called additional Tier 1 notes have lost about 1.9 percent this year, closing another door for investors seeking to escape a global market rout encompassing stocks, commoditiesand corporate debt. New capital rules have driven the losses by pushing lenders closer to thresholds that can prevent them from paying coupons on the notes, dividends or staff bonuses.
Banks laden with bad loans, such as Banco Popular Espanol SA and UniCredit SpA, have led the selloff. That’s because the European Central Bank’s rule change increases the significance of soured debt in determining thresholds for barring coupon payments. Losses imposed on senior bondholders at Portugal’s Novo Banco SA have also raised concerns about lenders in peripheral European economies.
Additional Tier 1 notes returned about 8 percent last year, surpassing most other types of debt, based on Bank of America Merrill Lynch indexes. The returns were mainly due to high coupon payments, which reflect the risk that the bonds can be converted into equity or written off if a bank is in danger of failing.
The new regulations will probably mean that lenders have to pay even more to sell the securities, said Simon McGeary, Citigroup Inc.’s London-based head of new products.
“If investors perceive that coupon-skipping is more likely, then they’ll potentially charge more for that,” he said.
The risk could be mitigated by weak banks cutting dividends and bonuses instead of payments on notes, or by regulators allowing limited payouts, he said.
Risky assets have slumped worldwide this year because of a slowdown in Chinese growth and a plunge in commodity prices to near 25-year lows. Euro and dollar junk corporate bonds have both lost more than 2 percent, while global stocks are close to a bear market. Investment-grade corporate debt has dropped 0.4 percent in euros, and returned 0.5 percent in dollars, Bank of America Merrill Lynch indexes show.
Additional Tier 1 notes sold by UniCredit and Banco Popular have had the largest declines among the 50 biggest issuers in a Bank of America Merrill Lynch index. The Italian lender’s 1 billion euros of 6.75 percent perpetual bonds dropped four cents on the euro on Wednesday to 83 cents. Banco Popular’s 750 million euros of 8.25 percent additional Tier 1 notes declined three cents to 85 cents.
“They’re no longer the stand-out asset class,” said Roberto Henriques, a London-based credit analyst at JPMorgan Chase & Co. “It’s more difficult to see them outperforming this year.”