The new bail-in regime being proposed for the big Canadian banks is credit positive for depositors and existing senior debtholders, says Moody’s Investors Service in a new report.
Back on August 1, the federal government published the proposed details of a new bail-in regime for Canada’s domestic systemically important banks (D-SIBs). Moody’s says that the new regime aims to ensure financial stability by maintaining the legal entity, contracts and critical services of a failing bank, while reducing the public cost of any bailout by ensuring that the burden of shoring up a failing bank would be shared with senior debtholders.
The rating agency says that the proposed regime is generally consistent with moves in other countries to adopt bail-in policies in the wake of the financial crisis, although it says that its plan for grandfathering existing senior bondholders represents a difference in the Canadian approach.
“The proposal is credit positive for depositors and legacy senior debtholders because they would both be excluded from bail-in and would benefit from an incremental layer of loss-absorbing securities below them,” Moody’s notes. “This additional loss absorption would be provided through the statutory conversion of future long-term senior debt into common shares of the bank.”
The bail-in regime would not apply retroactively to existing liabilities, Moody’s says, but new offerings of long-term senior debt would include specific disclosure about the conversion feature.
Under the proposed regime, the authorities would also have the ability to cancel the existing common shares of the bank, Moody’s says; but not new common shares that are created by the conversion of new contingent capital (CoCo) securities into equity. It also notes that all long-term senior debt would be convertible on a pro rata basis up to 100% of par value. “The amount of long-term senior debt converted would be determined at the time, based on ensuring that the D-SIB emerges from a conversion well-capitalized and able to operate,” it says.
This conversion of senior debt into equity would only occur after the Office of the Superintendent of Financial Institutions (OSFI) has determined that a bank is no longer viable, and any CoCos have been converted into equity. If, after that, the bank still isn’t considered viable, then the long-term senior debt would face conversion too. At that point, debt holders would receive common shares “based on a fixed conversion multiplier that would preserve the hierarchy of claims and ensure that creditors subject to conversion are made no worse off than under liquidation,” Moody’s explains.