Until Monday, only banks in the UK and Spain had clarity on whether Additional Tier 1 instruments were tax-deductible, a key aspect for this type of debt as it makes it a lot more cost effective to issue.
Italian and Dutch banks should now be able to join the issuance fray. Under the Basel III framework, banks can raise 1.5% of their 6% Tier 1 capital ratio in the form of non-dilutive equity-like instruments, which can also be used to improve banks’ leverage ratios.
“Dutch and Italian banks are very advanced in their capital plans and will be ready to issue Additional Tier 1 bonds in the first quarter of next year,” said Gerald Podobnik, head of capital solutions at Deutsche Bank. “We expect all European jurisdictions to soon allow provisions for these loss absorbing capital instruments because they make banks safer.”
Italian and Dutch banks have held back these types of bonds as they have waited and lobbied for government officials to modify tax rules to make them tax deductible.
This work appeared to pay off on Monday when the Italian government prepared an amendment, to be inserted in the 2013 budget law, to make it easier for banks to issue hybrid bonds to boost their capital starting from next year, according to a document seen by Reuters.
The Dutch Ministry of Finance appeared similarly open to the idea when it published a letter to parliament indicating it wanted to make sure that there is a level playing field within the EU for loss-absorbing capital instruments. Therefore they want to allow Dutch resident banks to deduct interest on AT1 instruments as of January 1, 2014.
According to capital experts, following these developments both Dutch and Italian banks are likely to go for a variety of structural options that have already been tested by other European banks.
“I think we’ll see a real mixture from the Italian banks that could go for temporary write down, write-back, permanent write-down or equity conversions,” said a DCM banker.
Instruments in both countries are likely to feature a 5.125% Common Equity Tier 1 trigger as is stipulated by the Basel III/ CRD IV requirements.
Top banks are likely to have to tempt investors with 6%–8% in annual interest on the bonds, an attractive option in a world of near-zero interest rates. But this is still cheaper than issuing equity, which typically costs around 10%–12%.
Out in front
In Italy and the Netherlands national champions like UniCredit and Intesa and Rabobank and ABN AMRO are likely to be first to test the instruments, with second tier names following.
“In the Netherlands I think Rabo will go out first and be followed by ABN AMRO whereas in Italy I think we’ll see UniCredit out first,” said a syndicate banker.
Federico Ravera, head of strategic portfolio at UniCredit, has already said his bank would look at doing a trade next year, market permitting. “We like the simple structure, with a temporary writedown as it gives investors upside potential,” he said at the IFR capital conference in November. “We need European investors to do their work and to be ready.”
In the past few weeks, Societe Generale, Credit Suisse and Barclays have unearthed over US$50bn equivalent worth of orders for Additional Tier 1 bonds, laying to rest any doubts about the strength of the global investor demand for these high risk securities where coupons can also be suspended.
The size and strength of the global investor base for such securities had been one of the greatest sources of concern for European bank treasurers given how much needs to be issued in the coming years.
According to analysts at JP Morgan, based on a peer group of 25 European banks, total issuance of Additional Tier 1 capital is likely to reach €31bn in 2014 while Citigroup’s analysts have said the overall global market for capital instruments including Additional Tier 1 and Tier 1 could grow to more that US$1trn over the coming years.
