RBC’s NVCC subordinated debt is credit positive for senior bondholders: Moody’s

Uncertainty surrounding regulatory regime may dampen interest in similar issues

By: James Langton
July 21, 2014 July 21, 2014
14:10

Royal Bank of Canada’s (TSX:RY) recent issue of non-viability subordinated debt sets a precedent for similar issues by other Canadian banks, notes Moody’s Investors Service. But the rating agency also says that the evolving regulatory regime for banks may dampen interest in these sorts of issues.

In a research note, Moody’s says that the $1 billion of Basel III-compliant non-viability contingent capital (NVCC) subordinated debt that RBC issued earlier this month is the first debt of this type to be issued by a Canadian banks.

“The NVCC issuance is credit positive because it increases RBC’s Tier 2 capital, providing senior bondholders with extra protection,” Moody’s says, adding that the notes provide loss absorption when a bank would otherwise be considered no longer viable.

“Like the inaugural NVCC preferred shares that RBC issued in January, the terms and conditions of these NVCC subordinated notes establish the precedent for future NVCC subordinated debt from other major Canadian banks,” Moody’s says.

Taken together with the NVCC preferred shares, the NVCC subordinated notes would “provide a means to recapitalize a failing bank without having to resort to public funds,” Moody’s says; adding that the notes convert into equity using a multiplier of 1.5x the notes’ value, compared with 1.0x for the preferred shares issued earlier this year, which preserves the claim hierarchy.

So far this year, Canadian banks have raised a total of $3 billion in additional Tier 1 capital, and now $1 billion in Tier 2 capital, Moody’s reports. And, it says that NVCC offerings from Canadian banks “have been upsized after underwriters’ options were exercised in full for many of the deals.”

Yet, it also says that it expects the banks to issue less Tier 2 capital than in the past. “Tier 2 capital will not improve leverage ratios, because impending OSFI leverage guidelines will incorporate metrics based on Tier 1 capital, rather than total capital (including Tier 2),” it says. “We also expect the uncertainty around the yet-to-be-defined Canadian bail-in rules to dampen investor appetite for Tier 2 capital, because institutional buyers fear the prospect of incremental dilution in the event that senior debt becomes convertible under the bail-in rules.”