The EC bank smackdown
Dexia and ING’s recent decisions to call some of their subordinated debt has puzzled market observers, as they seem to fly in the face of the European Commission and its crusade on burden-sharing for banks that have received state aid.
The Commission wants junior creditors of bailed-out banks to share some of the pain along with the public sector, and wants to make sure public funds aren’t used to repay equity or junior debt if a bank can’t. Holders of some of RBS’ subordinated debt recently found this out to their horror when the bank chose not to call the bonds at the first opportunity. The Dexia and ING bondholders, by contrast, will have had a nice pay day. The Dexia upper tier 2 bond was trading below par in the mid 70s area, according to CreditSights.
It looks like the EC wasn’t too pleased with Dexia and ING’s generosity, as last night it issued a stiff press release reminding banks of its rules. That’s not good news for any bondholders who had been hoping that the Dexia and ING calls may have signalled a thawing in the EC’s stance.
Here’s the EC statement:
State aid: Commission recalls rules concerning Tier 1 and Tier 2 capital transactions for banks subject to a restructuring aid investigation
Following questions from market operators regarding the possibility for banks which are the subject of pending European Commission investigations regarding the grant of restructuring aid to repay bonds before maturity, the Commission would like to recall that its Communication on restructuring aid to financial institutions of July 2009 (see IP/09/1180 and MEMO/09/350) sets out that “banks should not use state aid to remunerate own funds (equity and subordinated debt) when their activities do not generate sufficient profits”. In a restructuring context, measures which reduce the total amount of own funds (payments on hybrid instruments, avoidance of loss absorption, buy-backs, exercise of call options) are in principle not compatible with the objective of “burden sharing” (i.e. banks must pay a significant share of the costs of restructuring) and the “minimum necessary” requirement (i.e. the amount of state aid must not exceed the minimum necessary to allow the bank to restructure). For that reason, banks subject to a state aid investigation should consult the Commission before making announcements to the market concerning Tier 1 and Tier 2 capital transactions.
Transactions such as coupon payments, buy-backs and the exercise of call-options of Tier 1 and Tier 2 capital instruments reduce the total regulatory capital of a financial institution and put into question whether granted state resources were limited to the minimum necessary. Moreover, such measures may infringe the principle of burden sharing in so far as they protect the Tier 1 and Tier 2 capital holders from their exposure to the inherent risk of the investment.
Such transactions by financial institutions subject to restructuring obligations may therefore have implications for the compatibility of the aid received. On the other hand, the Commission may accept these transactions on the basis of a case by case assessment, after balancing the above mentioned principles of burden sharing and limiting aid to the minimum against the contribution of the transaction to the refinancing capability and return to viability of the institution. For that reason, banks subject to a state aid investigation should consult the Commission before making announcements to the market concerning Tier 1 and Tier 2 capital transactions.