Hybrid Investors Win in New Bank Capital Rules: Credit Markets 2010-09-14 16:13:54.418 GMT

By John Glover

     Sept. 14 (Bloomberg) -- 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 ($650 million) of undated 9.375 percent bonds callable in 2020 have risen 0.61 cent on the euro to 101.26 cents in the past two days, the highest level since Italy’s biggest lender issued them in July, according to data compiled by Bloomberg. Fifth Third Bancorp’s 6.5 percent bonds due 2037 and callable in 2017 rose 0.125 cent to 93.5 cents on the dollar today, the highest since November 2007, 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 Jim 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.
                       Relative Performance

     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 points, 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.

     A benchmark indicator of corporate credit risk in the U.S. fell for a fifth day. The Markit CDX North America Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses on corporate debt or to speculate on creditworthiness, declined 0.125 basis point to a mid-price of 102.5 basis points, the lowest since Aug. 9, as of 12:09 p.m. in New York, according to Markit Group Ltd. In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings rose 0.2 to 104.25.

                      Bondholder Protection

     The indexes typically rise as investor confidence deteriorates and decline as it improves. 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 contract protecting $10 million of investments.

     Ford Motor Credit Co., the second-biggest issuer of high- yield, high-risk corporate debt this year after Ally Financial Inc., may sell $1 billion of five-year notes, according to a person familiar with the transaction.

     The finance arm of Ford Motor Co. may issue the debt as soon as today, said the person, who declined to be identified because terms aren’t set. The Dearborn, Michigan-based company has sold $3.5 billion of junk-rated notes this year, Bloomberg data show. Speculative-grade debt is rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s.

                      Bank Hybrids Shunned

     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, Germany’s largest bank, said in December 2008 it wouldn’t call bonds because it was cheaper to keep the debt in the market.
 
     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.