Regulatory bank debt has been extraordinarily uniform following the introduction of the Basel III rules in 2009, but new formats are still possible — if issuers have the nerve.
After common equity tier one (CET1) resources, there are only two types of debt capital: additional tier ones (AT1s) and tier twos.
AT1s absorb losses on a going concern basis, upon the breach of certain equity triggers. They are perpetual in maturity, though callable after the first five years, and their coupon payments are discretionary.
Tier twos can only absorb losses once the issuer is a gone concern and has breached its point of non-viability. They have more of the features of conventional debt, with final maturity dates and coupons that must be paid.
Few banks have deviated from these standards, which tightly define which types of securities count as capital for regulatory purposes. But despite the rigidity of the Basel text, the world of bank capital is not quite set in stone.
Groupe BPCE showed this week that where there is a will to innovate, there may also be a way.
The French issuer stands almost alone in Europe in refusing to issue AT1, on the basis that it can find cheaper sources of CET1 through its cooperative network.
But the bank still reckons that issuing hybrid capital to gain “intermediate equity content” from S&P Global Ratings is worth its while.
Working with Natixis, one of its subsidiaries, the bank decided to revive a structure on Monday that combines some of the qualities of both AT1s and tier twos.
The new bonds rank alongside ordinary tier twos in insolvency, will have must-pay coupons attached, and will have final maturity dates.
But as with an AT1, they will absorb losses on a going concern basis. A quarter of the principal amount will be written down if BPCE’s CET1 ratio falls to below 7% of its risk-weighted assets.
Fortune favours the brave
The approach carried clear risks for BPCE. Not only did the issuer break new ground with its AT1/tier two crossover, it also included a number of other features that might have raised red flags with the regulator.
For instance, the new bonds will automatically lose their equity content with S&P after the first call date, which the authorities could have viewed as an unwelcome incentive for the issuer to redeem its debt.
At the same time, the shape of BPCE’s deal meant it risked falling through the cracks of the traditional bank bond market. Sitting somewhere between AT1 and tier two, the deal could well have proven too risky for some investment mandates but too expensive for others.
But the bond was nearly three times subscribed at reoffer, with final spreads that far more closely resembled those of tier two deals than AT1s.
The success of the transaction should be encouraging for other bank borrowers that are worried about whether there is a market or a regulatory justification for new and innovative products.
There might not be many others looking to replicate this exact structure as a way gaining intermediate equity content from S&P, given that AT1s would also do the trick.
But other banks could well be interested in testing new formats to satisfy specific objectives, particularly if they also get the regulatory benefit of Basel III compliance.
Structurers have talked in the past, for example, about whether there could be some value in developing the space between AT1s and equity — be it for rating agency credit or for stress test purposes.
ESG discussions have also thrown up an entirely new set of industry objectives, which some treasurers are keen to link to their capital transactions.
The BPCE tier two should be a cause for excitement in the FIG structuring community. It proves there is still some scope for tailored and bespoke capital products, outside of the norms of the Basel bank standards.