The Canadian Bank Bonds That Are About To Go Mainstream

Originally published June 27, 2017

Canadian fixed income investors may soon be holding a new kind of bond in their portfolios after it was recently announced that bail-in and non-viable contingent capital (NVCC) bonds issued by Canada's banks and life insurers will be eligible for inclusion in the FTSE TMX Canada Universe Bond Index starting next month.

FTSE Russell, the global index provider, said earlier this month that it expects bail-in bonds to become eligible upon confirmatory review of their final structure and once issued by a Canadian financial institution, while NVCC bonds that are newly issued on or after July 1, 2017 will become eligible effective that same date.

While not out of the blue, the decision has generated some buzz, particularly among investors with exposure to FTSE TMX fixed income indices via ETFs or other index products. One of the main queries we've been hearing from clients is simply, "What are these relatively new types of bond issues and how do they work?" To help answer those questions and more, here below is a short FAQ covering the basics on bail-in and NVCC bonds in hopes of providing a better understanding of two investments that could become a bigger part of portfolios in Canada.

What are bail-in and NVCC bonds?

Bail-in capital bonds and non-viable contingent capital (NVCC) bonds are distinct from existing debt issued by financial institutions primarily because they are both designed to convert into common equity in the event that regulators determine an institution is no longer viable. As for the distinction between the two, bail-in bonds are more senior in the capital structure to NVCC bonds, and would be converted to equity only after NVCC bonds have been converted.

Why were they introduced in Canada?

Both bail-in and NVCC bonds are structured to help strengthen the capital ratios of the country's banks and insurance companies, while also aligning with global capital standards under Basel III, a set of measures developed to strengthen the regulation, supervision and risk management of financial institutions. By converting to stock, these debt instruments help to shift the risk of a failing bank or life insurer to investors from taxpayers who might otherwise be on the hook if the government decided to "bail out" the financial institution in trouble as happened south of the border during the financial crisis.

What does the inclusion of these bonds to FTSE indices mean for Canadian investors?

Bail-in and NVCCs bonds are expected to replace existing debt over time and will effectively become the mainstream senior and subordinated bonds issued by the "Big 6" Canadian banks. Bail-in bonds could hit the market in early 2018; however, banks started issuing NVCC debt in 2014 and have roughly $16 billion currently outstanding, according to BMO Capital Markets. FTSE Russell is in the process of gathering feedback from stakeholders to determine the appropriate index treatment of NVCC bonds that were issued prior to July 1, 2017.

This post originally appeared on the BlackRock Blog.