August 6, 2014 / 3:21 PM / 3 years ago

Sub debt in the cold following BES wipe-out

LONDON, Aug 6 (IFR) - European banks’ most deeply subordinated debt has been coming under increasing selling pressure as the wipe-out of BES’s junior bonds and broader market turmoil gives investors a reality check.

Lenders have sold billions of Tier 2 and Additional Tier 1 debt since the beginning of the year, helped by seemingly insatiable demand for the asset class. But recent events in Portugal have led to a sell-off that appears to be taking hold.

Since the end of May, when BES first alerted the market about “accounting irregularities”, outstanding Additional Tier 1 bonds have been bashed around the market, with cash prices in some cases plummeting by as much as nine points.

For example, Deutsche Bank’s euro Additional Tier 1 bond is quoted at 96 today, according to Tradeweb, way off the 104 cash price it was at before the BES scandal hit the market.

Meanwhile, the cost of insuring subordinated debt, as measured by the iTraxx Subordinated index, widened by nearly 20bp during that period and is now at 103bp.

“Apart from BES, there’s a lot of macro news going on that we’ve all been ignoring for quite some time,” said a London-based portfolio manager.

“Israel, Russia and Iraq are all threatening stability. Bank capital is the riskiest credit product in the market, so when there are such light flows in the secondary market, you will see some pretty big moves.”

European supervisors have added fuel to the sell-off fire as they seem at pains to remind banks of the dangers of selling junior debt to retail accounts.

In a statement released on Tuesday, the UK’s Financial Conduct Authority (FCA) said it would bar UK banks from offering risky and complex hybrid debt to the mass market from October. ID:nL6N0QB3JJ]

Meanwhile, the European Banking Authority has sent out a reminder to financial institutions of their responsibilities when placing financial products with investors.

The Joint Committee of the European Supervisory Authorities (EBA, EIOPA and ESMA) highlighted specific risks posed to investors by contingent convertible instruments (CoCos).

While this is hardly new, investors believe the moves in Additional Tier 1 bonds have little to do with regulators’ opinions but a lot to do with market volatility.

“We’re holding off taking positions in CoCos until September, when primary issuance restarts and there is more liquidity in the market,” said the portfolio manager.

“As far as the reminders from regulators are concerned, considering the denominations these bonds are sold in, I don’t think it’s really a concern,” he said.

Bankers share that view and believe that the warnings from the EBA and FCA are unnecessary given the parameters of the market.

“This is not unexpected,” said a hybrid banker.

“The transactions executed over the past two to three years have generally been institutionally targeted and issued with high (100k+) denominations.” (Reporting by Aimee Donnellan; Additional reporting Helene Durand; Editing by Philip Wright)

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