Big banks face new ‘bail-in’ regime

TORONTO • The Canadian government has mapped out the specific process for creating a so-called “bail-in” regime for the country’s biggest banks aimed at keeping taxpayers off the hook in the unlikely event of a bank failure.

The bail-in structure, framed by the Department of Finance and complemented by new loss-absorbency guidelines from Canada’s main bank regulator, is part of a global response to the financial crisis of 2008. The banks will have to begin making changes next year but they will have until November of 2021 to reorganize their balance sheets to accommodate the new rules.

Analysts expect the impact on bank earnings and the cost of capital to be minor.

As opposed to a bailout, in which an outside agency such as the government provides financial assistance to a bank that is deemed nonviable, a bail-in involves automatically converting certain debt securities into regulatory capital to stabilize the financial institution.

Beginning in 2018, all unsecured long-term senior debt issued by Canada’s largest banks — those that are deemed systemically important domestically — will be convertible into equity should a bank need to be “resolved” or unwound, according to David Beattie, a senior vice-president in the financial institutions group at Moody’s Investors Service.

“There is no requirement for incremental capital,” he said. “There may be a slight spread premium for the new bail-in debt when issued.”

On Friday, about a year after the government passed bail-in legislation, the proposed bail-in regulations were released for a 30-day comment period. At the same time, and open to the same comment period, Canada’s main banking regulator, the Office of the Superintendent of Financial Institutions, proposed a total loss absorbing capacity (TLAC) guideline for the banks.

The latter is intended to ensure banks are prepared — through a combination of regulatory capital and the new convertible debt — to absorb losses and minimize any spread to the rest of the financial sector if they need to be recapitalized.

According to Beattie, the big banks should be able to meet OSFI’s new loss absorbency guidelines by 2021 “through an orderly rolling over of existing senior debt as it matures.”

Brian Klock, an analyst at Keefe, Bruyette & Woods, said he believes Canada’s banks will go beyond the regulatory requirements and maintain buffers of 100 basis points above the minimum total loss absorbency ratio of 21.5 per cent, and 50 basis points above the minimum leverage ratio of 6.75 per cent.

According to his analysis, the banks will have to increase their total loss absorbency capacity by $138.8 billion, and will do the bulk of that through refinancing current senior debt with what is known as non-viable contingent capital — another form of convertible securities. The balance would be done through issuing new senior debt that qualifies under the bail-in regime.

“We assume the newly refinanced and newly issued qualifying debt could carry a rate 50 bps (basis points) above current rates for similar debt,” Klock wrote in a note to clients, adding that this could dilute the banks’ estimated earnings per share in fiscal 2018 by 1.3 per cent to 1.5 per cent.

The federal government previously stated that bank deposits would be protected from any bank recapitalization and would not be subject to the bail-in regime.

In a note to clients, lawyers at Torys LLP said holders of bail-in debt would receive more common shares per dollar of claim than holders of subordinated debt and preferred shares in the unlikely event of an actual bail-in. This would be consistent with prior claims in the hierarchy of claims, the note said.

Meanwhile, any shareholder or creditor who wound up in a worse financial position as a result of a bail-in than they would have been in if the major bank had instead been subject to a “resolution power” of the Canada Deposit Insurance Corp. would be entitled to compensation from the CDIC, the lawyers wrote.

A SLIGHT SPREAD PREMIUM FOR BAIL-IN DEBT WHEN ISSUED.