Debt Fears Abate, With No Tiers Shed

By RICHARD BARLEY Tier 1 bank debt is back from the dead -- the latest evidence of a remarkable risk-appetite recovery. Three new deals have been announced in June, from the Netherlands' Rabobank Nederland, France's Credit Agricole and the U.K.'s Standard Chartered. Months ago, the very future of Tier 1 debt was in doubt. But the revival doesn't mean it will enjoy a long, fulfilling life. Tier 1 bonds -- which combine features of debt and equity, including the ability to skip interest payments and defer principal repayment -- were important sources of bank capital. The iBoxx bond indexes contain €185 billion ($259 billion) worth of Tier 1 debt. Banks liked them because they were cheaper than pure equity, enabling banks to report higher returns. But the crisis froze the market. Investors feared banks, particularly if nationalized, would defer payments or leave debt outstanding in perpetuity. Euro Tier 1 bond yields peaked 37 percentage points above government debt in March. The recent recovery reflects new realities. Triple-A-rated Rabobank paid 11% recently, compared with about 5.3% on one pre-crisis deal. That looks high, but interest is tax-deductible, reducing the true cost. And this may be a false dawn. Policy makers rightly question whether these structures are truly loss-bearing and should count as capital. The U.K.'s Northern Rock, for example, has continued paying interest on Tier 1 bonds since nationalization. The Bank of England's Paul Tucker last week called for a wholesale conversion of subordinated bonds into equity or senior debt. But new rules across Europe look some way off. While the window is open, expect more banks to jump through it. Write to Richard Barley at richard.barley@dowjones.com