The bail-out of Cyprus was characterised by the intention to make private stakeholders incur a higher proportion of bail-out costs as opposed to taxpayers. The willingness of authorities to bail-in depositors inevitably weakened the relative position of senior bondholders in addition to that of depositors themselves.
It is in the interest of banks, their senior bondholders, and their depositors, that levels of total capital are expanded
The perception of increased risk for depositors could theoretically cause deposit flight from the euro area, particularly from banks in periphery countries. So far, it seems that there was little contagion from Cyprus, with no signs of alarming deposit outflows. The rise in risk perception for senior bonds could result in higher funding costs for banks in financial markets. Even though investor sentiment remains generally supportive, from the perspective of banks it will become more important to boost capital levels to reassure investors that the risk of incurring losses on their holdings is remote.
It is increasingly evident that it is in the interest of banks, of their senior bondholders, and of their depositors, that levels of total capital are expanded.
While the importance of pure equity or Core Tier 1 capital has been emphasised by regulators for years, recent developments mean bolstering total capital levels will also become increasingly important. Basically, banks will be raising additional layers of capital as buffers to absorb losses. In practice, this means that European banks could be expected to issue more Tier 2 and similar capital securities.
Last week UniCredit issued a US$750 million 10-year Tier 2 bond yielding 6.375 per cent (currently trading at 6.13 per cent). This was its first subordinated bond in six months, and it was well received by the market. BBVA is currently issuing a perpetual Tier 1 (stronger loss absorption features than Tier 2 – therefore considered to be even more similar to equity capital) bond at a yield of around 9.25 per cent.
It seems the bond will have a complex, multi-trigger structure which includes a seven per cent equity conversion trigger – ie, it will convert into equity should the bank’s Core Tier 1 Capital level drop to seven per cent. This transaction is also attracting considerable interest because it is the first Additional Tier 1 bond that complies with the new Capital Requirements Regulation (CRR).
Regulation is also expected to boost the issuance of capital securities in the coming months, with the European Parliament adopting the Capital Requirements Directive (CRD) IV legislative package (which should increase clarity on the categorisation of capital security) a couple of weeks ago.
Turning to other aspects of the capital raising and restructuring processes, eurozone countries are facing various challenges in the clean-up of their banking systems. The Spanish government is trying to offload the banks it took over using €41 billion of bail-out funds. The state may need to provide additional funds to Banco Gallego – to make its acquisition by Banco Sabadell more attractive. Banco Gallego was nationalised when the Government acquired it for €80 million through the Fund for Orderly Bank Restructuring (FOBR).
However, the state was reluctant to add to its costs by injecting more capital before selling it to Sabadell. Additionally, it will not be attaching an asset protection scheme to the disposal. One other option being considered for the nationalised banks is to group them under a single holding company.
Lack of sufficient capital relative to potential losses is a major stumbling block. Fitch notes that asset quality deterioration is being underestimated. Apart from downsizing and consolidation, the rating agency estimates that around €13 billion of capital will need to be generated by bailing-in subordinated debt and preference share investors.
In Greece, it is estimated that an aggregate amount of €28 billion is required to replenish bank balance sheets. Most of the funds will be obtained from the Hellenic Financial Stability Fund (HFSF).
However, the four biggest banks plan to raise at least 10 per cent of the new equity capital from the private sector. According to an agreement with the EU and IMF, this will allow them to avoid state control. For example, National Bank of Greece, the country’s largest lender, just won shareholder approval for a capital increase amounting to €9.75 billion, which should allow it to remain under private control.
Once the recapitalisation is complete, in Greece as in other countries, it is hoped that banks will contribute to economic recovery. A concern over recent years has been that the effort to recapitalise banking systems, while necessary, resulted in excessive deleveraging that hindered economic growth.
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Curmi & Partners Ltd is a member of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business. This article is the objective and independent opinion of the author. The value of investments may fall as well as rise and past performance is no guarantee of future performance.
Karl Falzon is a credit analyst at Curmi and Partners Ltd.