* Write-up features could lower banks’ cost of capital
* Feature seen as integral to widening investor base for AT1
* Non-viability still a problem but borrowers have 80% clarity
By Jean-Marc Poilpre
LONDON, April 5 (IFR) - Hybrid debt structurers sighed with relief on Thursday when the EBA’s consultation paper on Draft Regulatory Technical Standards (RTS) made explicit reference to hybrid debt write-ups.
Market participants had been waiting for months for some clarity on Additional Tier 1 debt, which is in essence the equivalent for European banks of the Swiss CoCos.
The EBA’s 57-page document makes many references to “temporary write-downs and write-ups”, a feature that may help attract European institutional investors. So far the main buyers of these instruments have been the Swiss and Asian private banks.
“Write-up is now a possibility, this is positive for the market. The document is not final and things may change, but this clearly appears to be going in the right direction,” said Gerald Podobnik, co-head of capital solutions at Deutsche Bank.
The issue of write-ups has been a hot topic for a couple of years when the Basel Committee made its first guidance on the likely form of new hybrid structures. It is pushing for non-core Tier 1 and Tier 2 capital instruments with loss absorption mechanisms, triggered at the point of “non-viability”.
But regulators have made clear that they want to ban features in capital instruments that could “hinder the recapitalisation” of a bank, and write-ups seemed to have the potential to interfere with that process. The problem is that many fixed income investors were unhappy with the prospect of only having permanent write-down.
“Write-ups are very important because with permanent writedowns capital instruments get subordinated to equity - shareholders always have the potential upside from a recovery in share prices,” Podobnik added.
Khalid Krim, head of capital solutions at Morgan Stanley, echoed this view. “Confirmation that write-up will be allowed is a positive news for the market and investors as it will also give them the possibility of sharing the upside and not only the downside. For banks, this is also positive as it will make the instruments less expensive to issue than permanent write-down structures.”
The EBA paper does not address the thorny issue of non-viability language, but market participants expected that. The EBA is focusing on the technical aspects of the capital instruments, while the more general considerations on non-viability have been left to the Commission to define as part of the crisis management framework - a consultation paper on this matter, including bail-in of senior debt, was released by the European Commission last Friday.
Now structurers can start getting on with their work. “The release of this paper is important as it is very detailed and shows that the EBA is on track to have all the technical standards ready this year,” Krim said.
He reckons that the consultation paper provides about 80% of the clarity issuers need. “They now can use it as a basis to engage with their national regulators to tailor make their own structures. These standards will also be useful to update investors and walk them through the structure of CRD IV compliant AT1 instruments,” he added.
However, there is at least one area where bankers are likely to try to push their case during the consultation period: the proposed mandatory cancellation of coupons during a write-down period. Although coupons will remain optional and discretionary, institutional investors who will have already incurred a loss through the reduction of the principal amount would expect to be able to get a coupon paid on the prevailing principal amount during a write-down period, Krim said.
“This is especially true if a bank resumes dividend payment to shareholders before the full write-up of the AT1. Payments on reduced principal amount is already allowed when the write-down is permanent and we think the market wants to see alignment in the case of temporary writedowns,” he said.
Some bankers also plan to advocate the inclusion of dividend stoppers, or other similar mechanisms. They understand that such features are disliked by regulators who fear they could hinder recapitalisation but think it could be a problem for Europe’s banks.
“Countries outside the EU will allow them and, in a context of high competition globally for capital, investors will choose the banks that offer these stoppers,” one banker said.
The EBA put out for consultation fourteen regulatory technical standards, including Common Equity Tier 1, deductions from Common Equity Tier 1 and from own funds in general and transitional provisions on grandfathering.
These technical standards will be part of the single rulebook aimed at enhancing regulatory harmonisation in Europe and strengthening the quality of capital, the EBA said. Comments must be sent to the EBA by 4 July 2012. The new rules will come into force on January 2013. (Reporting by Jean-Marc Poilpre; editing by Alex Chambers, Julian Baker)