Ever since the Federal Deposit Insurance Corporation and the Bank of England revealed their joint thinking on the resolution of globally active, systemically important financial institutions (G-Sifis) last December the position of unsecured senior debt issued at the holding-company level by these firms has been under question.
At the heart of the regulators’ proposals is the single-point-of-entry approach, whereby resolution is enacted at the holding-company level. This means that in a distressed scenario unsecured debt held at the holding-company level will be written down to cover losses remaining after the equity has been exhausted.
This potential bail-in raises crucial questions for the banks as to how they should be structured and crucial questions for investors as to whether holding-company debt is where they want to be. This is because it converts senior unsecured debt into contingent capital.
If holding-company debt becomes the resolution buffer, minimum levels of such debt will likely be mandated. What such a level might be is unclear, but there could be plans to introduce legislation in the US calling for banks with more than $50 billion in assets to have subordinated long-term debt equivalent to 15% of assets. This raises the question of who needs to issue and who doesn’t.
According to CreditSights, the brokers are most comfortable with both Goldman Sachs and Morgan Stanley having 26% of total assets in this form. At the lower end the ratio for Citi is 17%, Bank of America Merrill Lynch 16% and JPMorgan 15%. Three US firms – Citi, BAML and JPMorgan – might, therefore, need to issue HoldCo debt if the orderly liquidation authority (OLA) regulation goes ahead as expected. The amounts would be manageable: $30.1 billion over 2.8 years for Citi, $18.5 billion over 1.3 years for BAML and $82.7 billion over 3.7 years for JPMorgan.
But if this structural subordination of holding-company senior unsecured debt into contingent capital goes ahead then it should become considerably more expensive. And if banks need to issue greater volumes of expensive subordinated debt to meet OLA requirements it could have a negative impact on HoldCo ratings.
"The transmission mechanism for these changes is the rating agencies," notes one London-based banker. "Banks could be downgraded because of this. In a one-notch downgrade, Citi and BAML would go to Baa3 at the holding-company level and that is a scary place to be."
In its recent fixed-income investor call Citi commented that in its view it was well positioned for any eventual debt requirement resulting from OLA requirements. It hopes therefore that the rating impact from these changes might not be as acute as some have predicted. Time will tell.