Moody's: Change to Germany's Banking Act would be credit negative for tradable senior unsecured debt

The inception of the EU's Bank Recovery and Resolution Directive (BRRD) has established depositor preferences for banks subject to that regime; the Finance Ministry in Germany (Aaa stable) is proposing an amendment to the German Banking Act (KWG) that would change the hierarchy of claims in an insolvency such that there would be a change in the insolvency waterfall within the senior unsecured debt class, says Moody's Investors Service.

Moody's believes that the proposed change in insolvency ranking would be credit positive for non-tradable senior unsecured liabilities -- for example corporate deposits, short-term debt -- and mostly credit negative for tradable senior unsecured debt. 

"Essentially, the proposed changes aim to establish a clearer demarcation between a bank's senior unsecured bonds and other debt instruments, thereby streamlining the bail-in procedure during recovery or resolution, and our recently implemented bank rating methodology provides us with the analytical framework to incorporate the proposed amendment to insolvency rankings into our Loss Given Failure analysis," says Alexander Hendricks, a Moody's Associate Managing Director within Moody's EMEA Financial Institutions Group.

"We acknowledge that the BRRD in its present form provides authorities with the tools to exempt certain claims from bail-in, but, we also think that these exemptions might increase the risk of litigation from disadvantaged creditors. The proposed amendment to the German Banking Act, explicitly subordinating tradable senior unsecured obligations, would create a layer of subordinated unsecured debt instruments and reduce this litigation risk," explains Bernhard Held, a Moody's Assistant Vice President -- Analyst and author of the report.

"The proposed amendment would also displace the current uncertainty regarding how losses are allocated in the senior unsecured class. By separating tradable instruments from other debt in this class, investors in tradable instruments won't be able to use the BRRD's no-creditor-worse-off principle to challenge the severity of losses that are applied to them and obtain a better recovery rate," adds Mr Hendricks.

Moody's estimates that the combined amount of tradable senior unsecured debt, subordinated debt and capital instruments would on average account for around 12% of total assets of the German banking system, which positions the German banking sector well to comply with the future minimum requirement for own funds and eligible liabilities (MREL) and total loss-absorbing capital (TLAC) levels. Moody's expects that the concentration in 2015 of the remaining Landesbanken grandfathered debt maturities will mean that some of the current MREL cushion divergence among the different sectors of the German banking system will dissipate by year-end 2015.

Finally, Moody's says that the German Finance Ministry has yet to specify a clear line between 'tradable' and 'non-tradable' senior unsecured instruments. Having said that, the rating agency would expect the new subordinated senior layer of liabilities to include senior unsecured tradable debt with a longer than one-year initial maturity but to exclude private placement debt, structured notes, money market liabilities maturing within one year and uncollateralised derivative claims, as well as large corporate and public-sector deposits. The remainder of non-tradable senior unsecured claims would thereby become relatively more senior, being subject to insolvency and bail-in loss absorption only after tradable senior unsecured debt, but before preferred deposits.