Regulatory cloud hangs over bank hybrid bonds

February 3, 2010

   By Jane Merriman
   LONDON, Feb 3 (Reuters) – European regulators want banks to boost their capital to protect against shocks but uncertainty about what type of hybrid bonds will qualify as Tier 1 capital is keeping a lid on new issues.
   Issuance of these bonds by European banks so far this year stands at almost nothing — they had been forecast to raise 20 billion euros ($28 billion) in Tier 1 hybrid bonds in 2010, according to estimates from Societe Generale.
   “The lack of issuance on the financial institutions side is because of the lack of clarity on the regulatory side,” said Antoine Loudenot, head of capital structuring group, global capital markets at SocGen.
   Hybrid bonds have played a major role in raising Tier 1 capital held by banks to support lending and other activities.
   They can have equity-like features such as the possibility of interest (dividend) payments being suspended or no fixed repayment date. But they are cheaper to issue than equity because hybrid investors get paid before shareholders in any default and therefore face lower risk. 
   Banks can also get tax relief on hybrid bond coupons.
   “There can be little doubt that many banks are keen to issue Tier 1 debt,” Citi credit analysts said in a research note. “It may be more expensive than it used to be, but it is still considerably cheaper than common equity – especially if interest payments are tax deductible.”
   But hybrids are more expensive to issue than plain vanilla senior bank bonds which would be repaid first in a default.
   Lower Tier 2 hybrid bonds have seen some signs of life this year, partly because there is less uncertainty over their future. This week, National Australia Bank <NAB.AX> launched a 10-year 1 billion euro Lower Tier 2 bond priced at 133 basis points over mid-swaps.
   Spanish bank La Caixa [CAIXA.UL] marketed a Lower Tier 2 bond last month, but has put the issue on hold, bankers said.
   
   TO ISSUE OR NOT TO ISSUE
   The picture might not get clearer until the middle of the year when regulatory guidance is expected to emerge.
   In the meantime, banks that need cash or capital, face hybrid redemptions or want to repay state aid have to decide whether to issue new hybrids and take a risk they might not qualify as capital under guidelines being shaped by the Basel Committee of Banking Supervisors. [ID:nLDE5BG15N]
   “There is uncertainty around what counts as ‘good quality’ capital going forward, said Prasad Gollakota, co-head of capital equity linked group at UBS.
   During the credit crisis, Tier 1 hybrids turned out to be less effective than expected at absorbing losses. Many banks continued to pay coupons and to redeem the bonds even when their capital was running low.
   “When push came to shove, the regulators did not have what they thought they had and now they want to change it,” said Roger Doig, credit analyst at Schroders.
   The Basel plans have also added to uncertainty over whether existing subordinated bonds would continue to qualify as capital under a ‘grandfathering’ scheme.
   “The Basel paper on Dec. 16 said any issuance after that date would no longer receive grandfathering,” Loudenot said. “Some issuers have talked to regulators on Tier 1 new issues or replacements and have not had a definite answer what to do.”
   Regulators have to balance devising a capital regime that makes banks safer while keeping investors onside.
   “Regulators want capital that absorbs losses when the institution is still a going concern,” said Doig. “But from a fixed-income investor perspective, this could put principal at risk even if there is not a default. It’s a grey area.”
   Lloyds <LLOY.L>, the British bank, used a form of hybrids that convert into equity in times of stress — so-called contingent capital — in a money-raising scheme last year. The concept of contingent capital got a cool reception from traditional fixed-income investors.
   “The holy grail for regulators and issuers is an affordable instrument which is acceptable as a core fixed income instrument and which meets the regulators’ objective of protecting depositors on a going concern basis,” Doig said. (Editing by Dan Lalor) ($1 = 0.7137 euro) ((jane.merriman@thomsonreuters.com; +44 207 542 3121; Reuters Messaging:jane.merriman.reuters.com@reuters.net))
 Keywords: BANKS CAPITAL/
  
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 Wednesday, 03 February 2010 14:32:22RTRS [nLDE610263] {EN}ENDS

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