REFILE-CoCo deluge unlikely despite EBA stamp of approval

Tue Feb 4, 2014 10:46am EST

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By Aimee Donnellan and Helene Durand

LONDON, Feb 4 (IFR) - European banks are unlikely to fill capital holes unearthed by the stress tests with the riskiest form of hybrid debt, despite being given the green light to do so by European authorities.

While the European Banking Authority said the impact of EU-wide stress tests would be assessed on banks' Common Equity Tier 1, Additional Tier 1 and Tier 2 could play a role in the stressed scenario, it said last Friday.

"I am not so sure that it will spur a level of activity in the Additional Tier 1 market," said Sandeep Agarwal, head of EMEA DCM at Credit Suisse. "I think the stress tests and AQR may even lead to equity raises first if shortfalls are being communicated to individual banks."

Under the EBA's requirements, the hurdle rate is 8% Common Equity Tier 1 for the baseline case and 5.5% for the adverse scenario. Additional Tier 1 and Tier 2 instruments with triggers above 5.5% could count in the adverse scenario, the EBA said.

As well as a focus on equity capital raises, however, bank hybrid issuance is being held back by other factors.

"A number of issuers are still waiting for confirmation from their regulators about the tax treatment of these instruments, which is the main factor holding up issuance. Also concerns around the emerging markets will have to ease before we are likely to see banks selling CoCos," said Robert Montague, a senior investment analyst at ECM Asset Management.

Worries over emerging market currencies have led to a massive sell-off in the wider credit market. That has driven the cost of insuring subordinated debt up by 26bp to 154bp in January, according to Tradeweb, spooking issuers and investors alike.

Meanwhile, Alberto Gallo, head of European credit macro research at RBS said the upcoming leverage ratio and the stress test would be the driver for issuance. "We expect around EUR30bn-35bn of supply this year as banks seek to solve for the leverage ratio," he said

UNHAPPY TRIGGER

Market participants also criticised the setting of a new trigger for the instruments, which they said could lead to confusion.

Up until now, eurozone banks had believed that the 5.125% minimum level set out by CRD4 would be enough to satisfy European regulators, but the new 5.5% trigger has brought further complications to a market that has failed to come up with a standard structure for these CoCo instruments.

As a result, bankers and investors now believe that a higher 7% trigger level - as seen on deals for the likes of Barclays or Credit Agricole - will become the norm. That would benefit regulators keen for troubled banks to be recapitalised without the help of taxpayer money.

"It's becoming evident that 7% is the more valuable trigger than 5.125% as we have seen in the case for UK, Switzerland, Denmark, or in the case of the recent issue of Credit Agricole," said Credit Suisse's Agarwal.

He added that the stress based 5.5% Common Equity Tier 1 ratio hurdle somewhat diminished the value of Additional Tier 1 with a 5.125% trigger.

"Banks will take direction from their local regulator and there are some that are still trying to gold-plate such requirements."

A head of syndicate said that issuers would be tempted to opt for instruments with a higher trigger, as something with only 5.5% might indicate that a bank was trying to address its capital needs solely for the stress tests.

"Also, by opting for 7%, it would allow banks to future-proof their capital as it's quite clear that there is still quite a bit of movement," the banker said.

While investors say they have a preference for the lowest triggers available, they also agree that 7% is likely to become standard fair.

"I think we are likely to see banks issuing higher trigger CoCos but second tier Italian and Portuguese banks that need to raise stress test capital are not in a position to do so because of the cost and market environment," said a fund manager.

"We are going to get to a stage where bank capital levels are so high that low trigger CoCos will serve no purpose to a regulator in a stressed environment," he said. (Reporting by Aimee Donnellan and Helene Durand, editing by Julian Baker)

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