Hybrid Investors Are Winners in Basel's New Bank Capital Rules
Investors in debt securities that banks sell to cushion against losses are proving the biggest winners from new capital rules designed to prevent a repeat of the worst financial crisis since the Great Depression.
UniCredit SpA’s 500 million euros ($643 million) of undated 9.375 percent bonds callable in 2020 rose 0.61 cent on the euro to 101.26 cents yesterday, the highest level since Italy’s biggest lender issued them in July, according to data compiled by Bloomberg. Wells Fargo & Co.’s 5.8 percent perpetual notes, from Wachovia Capital Trust III, rose 0.75 cent to 87.5 cents on the dollar, the highest since April, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The Basel Committee on Banking Supervision said Sept. 12 that starting in three years such subordinated hybrid notes won’t be counted as capital after their first so-called call date, giving banks an incentive to redeem the securities if they yield more than their other types of funding.
“Bonds that aren’t called will get a diminishing capital credit after 2013, and some may not get any at all,” said James St Johnston, co-head of fixed income at Matrix Corporate Capital LLP in London. “That gives issuers a concrete economic reason to call them.”
Under the current rules known as Basel II, so-called Tier 1 notes including hybrids -- about $1 trillion of which have been issued since 1999 -- count toward bank capital. That’s because as well as having elements of debt, they also have characteristics of equity in that they have no stated maturity. Equity investors are the first to get wiped out when a lender collapses.
Company Bonds
Bank of America Merrill Lynch’s U.S. Corporates, All Capital Securities index has returned 0.974 percent this month, compared with a loss of 0.315 percent on company bonds.
Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of similar maturity government debt fell 2 basis points to 173 basis points, or 1.73 percentage point, the lowest since May 18, Bank of America Merrill Lynch’s Global Broad Market Corporate Index shows. Yields averaged 3.593 percent, down from 3.637 percent Sept. 10.
Microsoft Corp., one of only four non-financial companies rated AAA by Standard & Poor’s, may sell bonds this year to back dividends and share repurchases.
Microsoft Notes
The world’s biggest software maker will try to raise as much as possible without jeopardizing its debt ranking, according to a person familiar with the plans. The company could raise at least $5 billion without putting its rating at risk, said Jason Brady, a managing director at Santa Fe, New Mexico- based Thornburg Investment Management, which oversees more than $56 billion, including Microsoft shares.
While Redmond, Washington-based Microsoft had $36.8 billion in cash and short-term investments as of June 30, much of that is held overseas, requiring the company to pay taxes to repatriate funds.
General Electric Co.’s finance arm led companies offering $13.8 billion of debt in the U.S., building on a surge of sales last week, with borrowing costs near record lows.
GE Capital Corp. sold $4 billion of bonds in an offering split evenly between 3- and 10-year debt. Sales yesterday followed $42 billion of issuance last week, the most since the five days ended Jan. 8, Bloomberg data show.
Yields averaged 3.886 percent, after dropping to 3.743 percent on Aug. 24, the lowest in the measure’s history dating to October 1986, according to Bank of America Merrill Lynch’s U.S. Corporate Master index.
Credit Risk
Benchmark indicators of corporate credit risk in the U.S. and Europe fell to the lowest since Aug. 9. Credit-default swaps on the Markit CDX North America investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, decreased 0.2 basis point to a mid-price of 102.6 basis points as of 7 p.m. in New York, according to index administrator Markit Group Ltd.
In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings decreased 0.6 basis point to 104.4, Markit prices show. The Markit iTraxx Asia index of 50 investment-grade borrowers outside Japan was little changed at 114 basis points as of 8:14 a.m. in Singapore, Royal Bank of Scotland Group Plc prices show.
The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a swap protecting $10 million of debt.
Consumer Debt
Bayerische Motoren Werke AG, Nissan Motor Co. and AmeriCredit Corp. led companies marketing at least $3.6 billion of bonds backed by U.S. consumer debt.
Munich-based BMW is issuing $750 million of debt tied to car leases, while AmeriCredit of Fort Worth, Texas, and Japan’s Nissan plan to sell $700 million and $1 billion respectively of bonds backed by auto loan payments, according to people familiar with the transactions who declined to be identified because terms aren’t public.
GE bonds were the most actively traded U.S. corporate securities by dealers yesterday, with 175 trades of $1 million or more. Exco Resources Inc., which sold $750 million of eight- year debt on Sept. 10, was the most active in junk bonds, with 128 trades. High-yield, high-risk, or junk bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- by S&P.
Emerging Markets
In emerging markets, relative yields rose 2 basis points to 279 basis points, according to JPMorgan Chase & Co. index data. Spreads for the month have narrowed 20 basis points, after widening 14 basis points in August, index data show.
Argentina’s credit rating was raised one level to B by S&P, which said the country’s strong economic expansion is helping it make debt payments. The rating, five steps below investment grade, is in line with Bolivia and Honduras.
The increase matches a move made by Fitch Ratings in July, one month after the government restructured $12.9 billion of bonds remaining from the country’s default in 2001.
Bank hybrid securities were largely shunned by investors this year on speculation borrowers wouldn’t redeem the notes. Concern that buyers would be left holding the debt in perpetuity was stoked when Deutsche Bank AG, Germany’s largest bank, said in December 2008 it wouldn’t call bonds because it was cheaper to keep the debt in the market.
Hybrid Securities
Plunging money-market rates and rising interest on other forms of bank funding in the wake of the financial crisis weakened banks’ incentives to redeem the hybrids.
Lloyds Banking Group Plc, the U.K.’s biggest mortgage lender, and Spain’s Banco Sabadell SA either refused to call their debt on their call dates or signaled they may not do so in the past two years, Bloomberg data show.
Under the Basel III rules, “capital securities with step- up language lose their capital credit at their call date,” said Eleonore Lamberty, a credit analyst at ING Bank NV in Amsterdam. “This supports the view that capital securities with a step-up will be redeemed at their first call date,” she said in a note.
As well as tightening up which securities can count as capital, the Basel Committee required banks to have a bigger cushion against losses. Under the new rules, which they have eight years to adopt, lenders must have so-called common equity equal to at least 7 percent of their assets, weighted according to their risk, including a 2.5 percent buffer to withstand future stress. Banks that fail to meet the rules will be unable to pay dividends, though not forced to raise cash.
Confidence in Europe’s financial system is increasing, allowing banks to sell 14 billion euros of bonds last week, the most in two months, Bloomberg data show.
“All other things being equal an increase in capital for the banking sector is of course good news for bondholders,” Gary Jenkins, head of credit research at Evolution Securities Ltd. in London, wrote in a client note yesterday. “The new regulatory regime” has helped restore “some confidence in the sector as evidenced by the recent amounts of bond issuance.”
Credit swaps on BNP Paribas SA, France’s largest bank, fell for a third day, dropping 6.2 basis points to 94.8, while contracts on Germany’s Commerzbank AG declined 8.7 to 94, according to data provider CMA.
