TLAC / MREL - eligible senior debt: investors often overlooking the fundamental angle

In a report published today, Scope Ratings notes that in the market debate and assumptions about where senior unsecured debt which will be TLAC/MREL-eligible sits in bank resolution, the degree of comfort with a particular bank’s credit fundamentals seems to be falling by the wayside. And yet, Scope considers that it is the overall fundamentals of the issuing bank which should be the paramount criterion for investors in its senior debt, even that which will be eligible for TLAC or MREL.

Scope says that it sees two angles for the TLAC/MREL issue: technical (where this debt would sit in resolution) and fundamental (what is the likelihood that the bank will end up in resolution). Currently, investors seem to be focused mostly on the technical angle, often overlooking the fundamental angle.

“Our view is that the latter should weigh more in investment decisions regarding senior unsecured debt,” says Sam Theodore, Scope bank analyst who authored the report. He went on by cautioning that “if investors are rightly concerned about a weakened bank’s senior unsecured debt potentially being bailed in, the same concern should not taint the investment view for a bank in decent-to-good credit shape”. This is so because, for the latter category, resolution remains a very remote probability.

In this context, the rating agency highlighted the positive role played by supervisors in preventing future resolution scenarios. The report notes that any modern-day supervisory body in Europe will do its utmost to prevent a bank from sliding into structural weakness leading to resolution.

A resolution situation would be a very painful development, adds Scope; even if taxpayers will no longer be called to recapitalise the bank, a ripple effect on market sentiment and a likely wider panic affecting other banks can be envisioned. Placing a large bank in resolution “would be far messier than elegantly passing the baton from competent to resolution authorities”, adds Theodore.

In this context, Scope’s report highlights the several layers of sequential supervisory steps expected to be taken to prevent a resolution scenario.