The end of the bank capital hybrid market?

Escrito el 2 abril 2009 por Antonio Rivela Rodríguez en Uncategorized

As I mentioned in a prior blog , I have never understood the bank capital arbitrage.


My forecast has always been crystal clear… as The Beatles woud say… That market will vanish in the haze.

Central Bank Regulators opened Pandora´s box when they allowed banks to consider hybrid bonds as equities for the purposes of calculating capital consumption. As a result many hybrid structures have developed: LT2 (Lower Tier 2), UT2 (Upper Tier 2), T1 (Tier 1) and a long etc.

Market crisis has killed these transactions:

1. Financials Credit spreads have rocketeered, and to make things worse (As I commented in a prior blog),

2. Governments have nationalised banks, and as a result: They are trying not to pay capital bond coupons or They are even reducing the notional of the bond (at book value), as we have seen recently with Commerz/Dresdner transaction (by 15% btw): Therefore, effectively reducing the coupon by 15%.

But now, there is a third effect coming into the market place. Many banks like UBS in Switzerland, RBS in Scottland or Banco Sabadell in Spain are buying back TIER capital products for the sake of strengthening their capital.

By the way, just to give some peace to investors: That´s good news. They do not force you to sell. They just provide with extra liquidity.

This is putting upside pressure on bond prices. So, as Bloomberg comments, prices could go up before market dies…

See Bloomberg article.


By John Glover

April 2 (Bloomberg) — Buybacks of some subordinated bank bonds may drive up the price of the securities, offering investors a profit opportunity, according to analysts at Societe Generale SA.

UBS AG and Credit Agricole SA are among issuers that bought back so-called lower Tier 2 bonds at a discount, using the profit to bolster capital, Matthew Maxwell and Nathalie Deliens in London wrote in a report. The securities may lose importance as a source of regulatory capital, prompting more banks to buy back the notes, they wrote.

The “market could disappear, but ironically prices might rally before it does as banks buy back LT2 issues to generate capital gains,” the analysts wrote. “The buyback allowed UBS to post a small increase in core Tier 1 capital and we believe other banks will follow suit.”

As writedowns and credit losses at financial institutions worldwide approach $1.3 trillion, regulators and investors are focusing their attention on so-called Tier 1 capital, the type of bank debt that has the greatest capacity to absorb losses.

Adair Turner, chairman of the U.K.’s Financial Services Authority, two weeks ago recommended following the Swiss authorities’ lead and not count lower Tier 2 notes as capital. Both regulators are using the ratio of Tier 1 capital to total assets as measure of financial strength.

“The current financial crisis emphasizes the need for capital to absorb losses but LT2 capital does not have this capacity,” the analysts wrote. The Swiss decision to exclude the debt from capital by 2020 “could sound the death knell for the LT2 market.”

Banks most likely to buy back lower Tier 2 notes are those with high Tier 1 ratios and significant amounts of lower Tier 2 bonds, the analysts wrote. These include Credit Suisse Group AG and UBS, the analysts wrote.

Other possible buyers for Tier 2 debt include Barclays Plc, which is “under pressure” to raise its Tier 1 ratios, Danske Bank A/S and Banco Santander SA the analysts said.



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