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Bank debt investors unfazed by acceleration covenant removal

By Will Caiger-Smith

NEW YORK, Jan 27 (IFR) - Investors have piled into new bank senior bonds this year, shrugging off the removal of certain covenants that in the past have allowed them to demand accelerated repayment.

Since the Federal Reserve finalized its Total Loss Absorbing Capacity rules in December 2016, US banks have issued US$29.75bn of senior holdco debt with updated acceleration language.

The language removes investors' ability to demand acceleration in all cases except for payment default, bringing the bonds in line with the final TLAC rules.

Some investors say that puts the new bonds at a disadvantage compared to older deals that contain a broader range of covenants that can trigger acceleration.

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"A big part of the senior debt definition is a right to accelerate," said David Knutson, head of credit research for the Americas at Schroders (Frankfurt: 929969 - news) .

"Without that, it starts to smell like subordinated debt. These new deals are not subordinated debt, but they should come with a premium."

However, the removal of those covenants does not seem to have affected pricing or demand for deals issued so far this year.

Some tranches offered relatively generous new issue premiums, but market participants put that down to the large deal sizes, saying acceleration was not really an issue.

"You're not getting much benefit from having these covenants in the first place, so ultimately their value is not that high," said one US investor.

"The bigger question around TLAC really concerns the ability of the regulator to put a bank into resolution."

The covenants in question range from restrictions on corporate mergers and asset disposals to requirements to maintain offices for notices and payments.

The Fed disqualifies debt from counting towards TLAC if it allows acceleration for reasons other than payment default - unless it was issued before the end of 2016.

Whether valuable or not, many buysiders said there was no chance of investors demanding a premium for the removal of such covenants while the outlook for banks was so positive.

"Bond investors are focusing on the positive aspects of bank earnings," said Jon Curran, a portfolio manager at Standard Life.

"For bondholders, there is a lot to like about the US banks right now - higher rates, a stronger economic backdrop and potential regulatory relief."

NO CONCERN

European investors are also unfazed about the removal of acceleration rights in US bank debt.

Wells Fargo (Swiss: WFC-USD.SW - news) found 2.9bn of demand on Tuesday for a 2bn five-year floater, which priced at three-month Euribor plus 50bp.

Wells sold a £500m short seven-year the week before, which also saw robust demand.

A lead banker said he did not receive any questions from investors about the new acceleration language.

Some buysiders said they had noted the removal of the covenants, but that it made little difference in reality.

"The thing is, for bank senior paper, there really aren't any substantial covenants that I could picture us holding the bank to anyway, given that a payment default would still be an acceleration event," said Gregory Turnbull Schwartz, an investment manager at Baillie Gifford.

"I would prefer not to pay more for the 'lesser' bond, but in terms of assigning a number of basis points, I think one could properly be accused of forest and tree issues in this instance and would be better off working harder on understanding the issuer fundamentals."

This bodes well for the region's banks, which may also have to remove senior investors' acceleration rights if the European Commission proposals released in 2016 go through unchanged.

The proposals would allow accelerated payment of interest or principal only in the case of a bank insolvency or liquidation.

Lloyds Banking Group removed acceleration language from its recent US$2.75bn five and 10-year deal sold earlier this month.

Royal Bank of Scotland (LSE: RBS.L - news) has not sold a US dollar deal so far this year but has updated its EMTN documentation, according to two sources.

Under its updated programme, the bank can toggle between non-restrictive events of default, in line with traditional senior, or restrictive events of default more akin to subordinated debt, whereby investors' acceleration rights would be stripped out. (Reporting by Will Caiger-Smith; Additional reporting by Alice Gledhill, Natalie Harrison and Helene Durand, editing by Julian Baker)