Six of Canada’s biggest banks may issue as much as US$120bn in senior unsecured debt in the next three years to meet new Total Loss Absorbing Capacity (TLAC) rules that become effective September 23, according to a CreditSights webcast.
The research firm however expects no major panic or drama and anticipates requirements to be met by the refinancing of legacy senior unsecured debt.
The new rules become effective on September 23, but banks have until November 1 2021 to meet the TLAC requirements.
Under the requirements, banks must maintain a minimum risk-based ratio of 23% which includes a 1.5% domestic stability buffer, and a leverage-based ratio of 6.75% of total assets.
TLAC securities will comprise issuance of regulatory capital which is Additional Tier 1 and Tier 2 securities plus the senior bail-inable unsecured debt issued after September 23.
Based on current ratios, the six banks are already in compliance with TLAC requirements if legacy senior debt is included, said Peter Simon, senior analyst at CreditSights.
This means banks simply have to refinance such debt in a bail-inable format post September 23 to meet required ratios under the new rules.
Royal Bank of Canada would have the largest shortfalls with CAD44bn (US$34bn) of debt to refinance, followed by Bank of Nova Scotia and Toronto Dominion with between CAD30bn-35bn each. National Bank of Canada had the lowest shortfall with CAD7bn, it said.
CANADA VS US
Some 60-70% of new senior bail-inable debt issuance is expected in Canadian and US debt markets where refinancing would be cheaper given investors’ familiarity with these credits.
Indeed, banks are expected to pay just 8bp-15bp over legacy bonds, with a bias toward the tight end of that range.
The spread differential between Canadian legacy debt and the new bail-inable securities may not be larger than what US banks pay on holding company TLAC bonds versus senior bank level debt.
“Canadian banks are in a benign credit environment so investors are likely to price in a low likelihood of failure,” said Simon.
One FIG banker told IFR that Canadian banks were likely to target their domestic market first before coming to US dollars, and that those deals could come very quickly after the new regime comes into effect.
“There are pros and cons to being early in the US dollar market,” the banker said.
“These are new structures so there is a lot of excitement, but the first US dollar bonds that come would have to come cheaper than Canadian dollar deals.”
RUSH BEFORE RULES
Some Canadian banks – such as CIBC and Toronto-Dominion - have been active in the US dollar market as they are keen to create benchmarks for the new TLAC-eligible issues which are expected to offer a premium.
“They should price attractively at first, but that will eventually fade away,” said the banker.
Indeed, Canadian banks have increased issuance of senior unsecured debt this year across global bond markets before September 23.
That is because senior debt issued after that day is expected to be more expensive than bail-inable debt.
The legacy bonds are also expected to trade tighter as they would stand higher in the capital structure to bail-inable debt.
INVESTOR FRIENDLY
The bail-in rules are also investor friendly because of a “no creditor worse off” policy.
Canada’s Deposit Insurance Corp would compensate investors if they incurred greater losses than under a liquidation scenario. Bail-in debt holders would be pari-passu with depositors for the purposes of the liquidity calculation.
And unlike the experience in the US, Canadian banks’ transition to the new TLAC rules is expected to be straight-forward.
“Most of the shortfall will be met by refinancing so banks will not need to pull forward TLAC issuances to issue debt at a faster pace than maturities like the US banks did,” said Simon.
Recent investor presentations from Canadian banks also relayed the same message.
“TD expects to meet the TLAC supervisory target by the implementation date in the normal course without altering our business as usual funding practices,” the bank said recently.
BMO said the requirements were “manageable” and there was no need for incremental funding.
Canadian banks are expected to issue bullet senior debt through their opcos with maturities that ensure they are TLAC eligible in 2021.
Some could consider using callable structures like US banks but it will be dependent on whether that call option increases funding costs or not.