* New TLAC requirements to put added strain on European banks
* French, Spanish, UK banks to be among most affected
* Difficult corporate restructurings eyed
* Failure to meet new requirements may stop dividend and AT1 payouts
By Helene Durand
LONDON, Oct 24 (IFR) - European banks could be forced to sell billions of euros of subordinated debt or completely reshape their corporate structures if global regulators go ahead with new rules seeking to stop banks being “too big to fail”.
According to the most pessimistic estimates, the European banking sector as a whole could need to raise as much as 1trn of subordinated debt to meet new standards for Total Loss Absorption Capacity - or TLAC - that the Financial Stability Board is set to agree in November.
The FSB is the international body that brings together the work of national financial authorities and wants banks to hold an additional safety buffer equivalent to 16% to 20% of their risk-weighted assets.
This potential supply comes on top of the up to 600bn European banks need to raise to meet the already demanding minimum capital requirements set by the Basel Committee and competing supply from banks in other regions that will have to meet the same requirements.
“If you were to add the numbers today for the Global Systemically Important Banks (GSIBs) in Europe, they are 500bn short of TLAC in the right form or in the right place,” said Simon McGeary, head of the new products group at Citigroup.
“The problem for many European banks is that they have senior but it tends to be at the operating company .”
Analysts at BNP Paribas said in a recently published note that they expect the additional requirements to be met with a mix of Tier 2 debt, holdco senior debt and a reduction of risk-weighted assets. They estimate that for the European sector as a whole - that is, for the GSIBs and smaller institutions - TLAC could mean 1trn of subordinated issuance.
“This is a significant potential additional supply at a time when investors are usually long the asset class and we struggle to find the marginal buyer at the wider levels,” the analysts wrote.
The gap is also partly the result of banks reducing total capital in recent years as they focused on increasing their Common Equity Tier 1 level.
“Some banks have been running down their total capital position, losing regulatory capital credit on grandfathered subordinated debt and hybrids, and in some cases, have shortfalls of as much as 15bn-20bn on a fully loaded basis,” said Khalid Krim, head of European capital solutions at Morgan Stanley.
Krim added that if the TLAC standards are implemented as currently envisaged, banks in the UK, France and Spain could be hardest hit.
In a note published this week, rating agency Scope said that BNP Paribas could have a shortfall of more than 25bn based on a TLAC requirement of 20% of risk-weighted assets.
Santander and BPCE are not far behind, according to Scope, with 17.5bn and 15bn shortfalls, respectively, at the 20% level.
While the FSB has so far said the TLAC requirements would only impact GSIBs, market participants agree it would not be long until it was rolled out to other institutions that might not be globally important, but are of systemic importance to individual countries.
One potential saving grace for European banks could be that senior debt is included in TLAC calculations. Under the new European Bank Recovery and Resolution Directive, senior will be “bailinable” from 2018 and could therefore be used to fill some of the TLAC requirements.
However, many believe that banks, being such big users of the wholesale markets, will do their best to protect senior debt as much as they can and would not use it to meet the new TLAC requirements, raising subordinated debt instead.
Also, for most, that senior debt has been issued at the bank level, meaning it would have to be restructured to be at the holding company level so it can be counted in the TLAC buffer.
Kapil Damani, head of capital products in the DCM solutions group at BNP Paribas, said that while Tier 2 bonds could be one solution to fill the capital hole, other forms of structurally subordinated debt could emerge.
“I wouldn’t be surprised to see other types of contractual instruments such as Bail-in Bonds appear in order to meet the new TLAC requirements,” he said.
Instead of restructuring operating company senior debt, another solution to help overcome the dearth of applicable capital - and to help resolve a bank in difficulties - would be for banks to issue new debt via holding companies. Indeed, banks in the UK and Switzerland are already starting to sell debt via holding company structures.
But, as Morgan Stanley analysts point out, doing so is not always easy. “First, away from the UK and Switzerland, few European banks have holdcos. Even in those two countries, banks are really only just starting to issue from that level. Whilst other European banks could also set up holdcos and issue from them, it’s not particularly straightforward.”
If the FSB goes ahead with the introduction of new TLAC standards as expected, market participants say banks will have little choice but to fall into line - even if that means issuing a wave of new debt.
“Making TLAC a hard requirement under Pillar 1 has real consequences. If banks don’t fill it, it basically means that equity drains out of your buffers, which is the lever regulators use to control banks,” said Citigroup’s McGeary.
Being non-compliant with TLAC standards would imperil a bank’s ability to make discretionary distributions such as dividend payments or Additional Tier 1 coupons.
“If the regulator wants to put pressure upon banks it could make discretionary payments TLAC-dependent - so many AT1s coupons will be at risk,” said Jorge Martin Ceron, a fixed income portfolio manager at Lombard Odier. “This won’t come into effect until 2019 - so [it might not be considered] an issue for investors - but many are already differentiating between bonds of issuers with sufficient combined ratio buffers [and those without].” (Reporting by Helene Durand, Editing by Matthew Davies, Julian Baker)