Nordics await a piece of the AT1 action
From the moment Svenska Handelsbanken reopened the bank capital market for 2014, forecasts of the asset class being the one to watch this year have come good. The only obstacle to Nordic banks successfully joining the action in hybrid form appears to be regulatory uncertainty. Susanna Rust reports.
If a recent Eu1.5bn (Skr13.2bn) 10 year non-call five Tier 2 issue for Svenska Handelsbanken is anything to go by, Nordic bank capital will be met with open arms this year. Tapping the market on the first day of new issuance in 2014, the Swedish bank drew some Eu5.5bn of orders to allow pricing at 143bp over mid-swaps — the tightest re-offer spread for such a Tier 2 issue since the collapse of Lehman Brothers.
“A screaming success” that fed investors’ appetite for “low beta in sub”, is how one syndicate banker described the trade.
Indeed, with yield-hungry investors showing signs of waning interest in core bank bonds given prevailing tight spreads, core issuers would be better advised to tap the euro market for subordinated funding, according to Alex Sönnerberg, Nordic DCM origination at Crédit Agricole CIB.
“It’s no surprise that the majority of supply in senior financials this year has come from peripheral banks, which satisfy yield-driven investors,” he says. “Therefore it makes more sense for core issuers with subordinated funding needs to tap the euro market right now given they can offer investors an attractive coupon from a high quality credit with low probability of default whilst still achieving a tight spread.”
Handelsbanken’s deal was its first sale of subordinated debt since 2007 and marked the beginning of what is expected to be a wave of subordinated or hybrid debt issuance from European banks, with a focus on Additional Tier 1 (AT1) but including Tier 2 transactions.
According to Gwenaëlle Lereste and Pascal Decque, financial analysts at Crédit Agricole CIB, AT1, the new category of hybrid capital with contractual loss absorbency mechanisms introduced by the Basel III framework, is expected to be the segment of 2014.
European banks are expected to issue Eu25bn of euro denominated AT1 instruments in 2014, and around Eu59bn-Eu66bn in total including US dollars. Looking further down the line, the euro benchmark market could exceed Eu400bn, according to the analysts.
The outlook for Tier 2 subordinated instruments, the segment that Handelsbanken tapped for the bank capital market’s reopening this year, is also positive, they say, estimating some Eu20bn of issuance in 2014.
“Banks are queuing up: top European names and potentially good second tier names,” say the analysts. “The market has opened to peripherals and there will be more equilibrium in issues between euros and foreign currencies.”
Locked and fully-loaded
As far as regulatory requirements are concerned, Nordic banks are generally deemed to be in a good position, in that they are approaching, meeting, or exceeding the toughest standards in the European Union.
In Sweden, for example, according to rules set out in November 2011, banks are required to have a Common Equity Tier 1 (CET1) ratio of at least 12% by 2015, with a countercyclical buffer add-on of up to 2.5%. This compares with a minimum common equity requirement of 4.5% by 2015 under the unadulterated EU bank capital package, the Capital Requirements Directive/Regulation (CRD IV/CRR).
According to Crédit Agricole CIB’s analysts, Swedbank exceeded a fully-loaded Basel III CET1 target ratio of 18% by six percentage points as of the end of 2013, and SEB was two percentage points above the same target ratio.
Indeed, in Sweden “the main story” is dividends, says Sönnerberg.
“Shareholders want banks to return capital, especially given that levels are above and beyond regulatory requirements,” he says, “but the FSA, Riksbank and the government are trying to force banks to hold on to capital.
“Once there is clarity on the regulatory requirements banks will know how much they can pay out in dividends or buy-backs, and what they can issue in terms of hybrid capital instruments.”
Alex Sönnerberg, CACIB
Nordic bank capitalisation also looks good when it comes to metrics such as the Risk Adjusted Capital (RAC) ratio used by Standard & Poor’s.
According to the rating agency, the weighted average RAC for the 22 Nordic banks it rates is 9%, compared with an average of 7.4% for the 100 largest banks S&P rates globally. Each of the Nordic banks exceeds the 7.4% level. Among the larger Nordic banks, S&P’s assessment of a bank’s capital strength has a positive rating impact only on Finland’s Pohjola Bank, although in July the rating agency revised its outlook on Swedbank to stable in part because it forecast an improvement in the Swedish bank’s capital ratios.
The rating agency noted that Nordic banks significantly increased capital between 2009 and 2012, on an Adjusted Common Equity (ACE) and Total Adjusted Capital (TAC) basis, and that the growth of bank capital slowed this year as banks have reached or are approaching regulatory capital targets.
However, it expects Nordic banks’ capital strength to continue to improve.
“We expect that, over the next 18-24 months, the RAC ratios of many large Nordic banks will approach 10%, which is the minimum to qualify as having ‘strong’ capital according to our criteria,” said S&P. “We expect some of the 14 smaller banks to approach the 15% mark in the ‘very strong’ category.”
Fitch also notes that Nordic banks already have high capital ratios, but still sees reasons for them to build on that.
“Fitch expects Nordic banks to keep a high buffer to maintain investor confidence in the context of the current development of resolution and bail-in legislation,” said the rating agency. “This is further driven by some regulatory uncertainty on adequate risk weight floors for mortgages, additional buffers for domestic SIFIs and leverage.”
At S&P, the expectation is that Norwegian and Danish banks will continue to accumulate equity capital, but that large banks in Sweden in particular will begin to issue hybrid Tier 1 capital instruments this year to improve capital efficiency, not least because of growing speculation in the market about increased dividend pay-outs.
“Nordic banks haven’t issued AT1, but I don’t think that will continue,” says Sean Cotton, associate director, financial institutions, S&P. “The Swedish banks in particular used to have a relatively high share of hybrid capital and those banks that are in excess of capital requirements and generating strong earnings will at some point turn to capital optimisation.
“They will look at the cost of capital and how they can better build the capital base, for example by slowing equity accumulation and increasing the share of hybrids. As AT1 instruments are perceived to be loss absorbing, it seems that banks will find more of a balance than what they have now.”
Champing at the regulatory bit
Stefano Rossetto, hybrid capital and liability management, Crédit Agricole CIB, says that Nordic banks’ non-equity capital issuance plans will be influenced by a range of considerations, such as leverage ratio requirements, changes in risk weights, Pillar 2 requirements, and requirements for bail-inable debt in the context of bank recovery and resolution frameworks.
“All of these relate to the target capital structure for a bank,” he says. “Pillar 2 requirements vary from jurisdiction to jurisdiction, and in the Nordics they are something that banks will have to assess as part of their total capital considerations.”
He notes that the inherently lower risk weights shown by Nordic banks mean that their capitalisation appears relatively weaker when measures based on total assets or total liabilities are used, and that a leverage ratio higher than 3%, as has been discussed by some European policymakers, could be a potential source of capital need, for example.
Denmark has yet to introduce a leverage ratio, but a government expert group is assessing the need for it to be introduced in addition to risk-based capital requirements, while some analysts note that a “Swedish finish” to the EU leverage ratio would be in line with how policymakers there have acted so far. In Norway regulators have also expressed a need for a leverage ratio.
Another consideration when it comes to the outlook for Nordic bank capital issuance, according to Rossetto, is that there is still uncertainty about the types of instruments that can be used to meet various capital requirements and what hybrid structures will be accepted by regulators.
“What the Nordics have issued so far is generally plain vanilla Tier 2, which is not that different from Basel II,” he says. “What will be interesting is what kind of hybrid instruments will be allowed and favoured by local Nordic regulators to cover additional capital requirements to boost major Nordic banks’ loss absorbency, or cover specific risk exposures.”
Indeed, in Sweden the banks are very eager for the regulator to divulge details about various requirements so that they can get on with fine-tuning their capital structures.
“The standard answer you’ll get from most Swedish banks is that we are waiting for regulatory clarification,” says Gregori Karamouzis, head of investor relations at Swedbank, “on issues such as what the buffer requirements will be, what type of capital will count toward those buffers, and what structures will be allowed for loss absorbing instruments.”
Clarity on these aspects will allow the issuer to calibrate its capital structure and meet its needs in the most economically efficient way, he says, for example by using standard Tier 2 debt, the cheapest bank capital available, to satisfy as many requirements as possible.
Rodney Alfvén, head of investor relations at Nordea, says that Nordea will issue CoCos when Nordic regulators have clarified their requirements and how these can be met.
“We are above our capital targets, but have redemptions in the coming years so will want to replace these with new issuance,” he says. “We have the mandate from our AGM to issue CoCos and theoretically could pull the trigger quite quickly, but we are waiting to get clarity from the regulators.”
He says that Swedish banks are lacking clarity on what the Pillar 2 requirements will be and what type of capital will count toward these requirements, and how trigger points and other features of CoCos will be treated by the Swedish regulators.
Hampus Brodén, head of group financial management at SEB, says the regulatory uncertainty means that it is difficult to say at the moment whether SEB will be issuing hybrid capital in the early stages of 2014, even though market developments are encouraging.
“The mood seems to be quite upbeat and there is appetite for these kinds of instruments, which bodes well,” he says, “but the decisive factor remains regulatory clarity.
“We have high hopes that we will be perceived as more than sufficiently capitalised, but until we have clarity it is too early for us to have a firm view. It’s just not possible to tell where things are going to end up and at the moment we are forced to sit on our hands a bit.”
- Hampus Broden, SEB
Karamouzis, meanwhile, is confident that Swedish banks will still meet with demand even if they are not able to join in the AT1 market straight away.
“In terms of quality, we fill a different bucket, so we will still have a role to play in investors’ portfolios because of the lower risk profile we offer,” he says.
Bank capital regulation in Finland, notes Sönnerberg, appears to be aligning itself with the Basel III recommendations without “pushing the boundaries”, but could follow the direction Sweden is taking, as is often the case.
“The banks there are relatively well capitalised, without having any imminent requirements to fill buffers, so I think they will lay low and wait for further clarity from the regulator,” he says.
In Norway, the latest development on the regulatory front was a mid-December announcement from the finance ministry that banks will be required to hold a countercyclical capital buffer of 1% of risk-weighted assets as of July 2015. That move came after the ministry in October increased loss given default (LGD) parameters for mortgages.
Like its Swedish counterparts, Norway’s DNB has meanwhile been able to take advantage of the attractive conditions in the Tier 2 market. When Handelsbanken set the new post-Lehman tight, it took that record away from DNB, which had set the previous tight with a Eu750m (Nkr6.30bn) 10 year non-call five issue in September 2013 at 177bp over mid-swaps.
Thor Tellefsen, senior vice president and head of long term funding at DNB, said that the issuer had been planning for some time to launch a Lower Tier 2 transaction before the end of the year.
“It is part of our regular refinancing of Lower Tier 2 capital that we have called and it goes toward meeting Basel capital requirements,” he said.
Danske eyes AT1 after saga
Could Danske Bank end up pricing the first Nordic CoCo? The Danish lender has already issued CRD IV-compliant Tier 2 bonds, but has waited to sell AT1 securities because of uncertainty about two tax matters.
One concerns the treatment of coupons and whether these will be tax deductible, as has been the case for the bank’s hybrids since 2004, and the other is whether there would be a tax liability stemming from a potential future write-down, which could imply lower capital recognition upfront.
The issuer is expecting clarity on the first matter upon the passage of government SIFI legislation, which could be passed this quarter, while the second issue was being looked at by the European Banking Authority in 2013 but has since been referred back to national regulators.
“The situation is now much more straightforward because we know the regulators we should talk to about it,” says Peter Holm, senior vice president, head of group funding and cover pool management, treasury, at Danske Bank. “We would like clarity on both issues.”
Like other Nordic banks, Danske has in the preceding years boosted its capital in anticipation of higher capital requirements heralded by the Basel III framework, but in the Danish bank’s case an additional factor has been in play — a Dkr24bn (Eu3.22bn) government hybrid capital loan taken out in 2009 and up for prepayment in April this year.
“Ever since the government hybrid went on our books we have been planning for the prepayment option,” says Holm.
In April 2011 the bank raised net proceeds of Dkr19.8bn via an equity issue and in October 2012 it launched a Dkr7bn equity issue, after having a month earlier sold a $1bn (Eu731m) 25 year non-call five Eurodollar Tier 2 issue aimed at improving its S&P RAC ratio and boosting the quality of the bank’s capital.
Developments in 2013, however, threw a spanner in the works, due to the aforementioned tax questions cropping up and changes to S&P’s bank hybrid capital methodology. The latter resulted in S&P classifying the so-called RAC issue from September 2012 as having “minimal” rather than “intermediate” equity content, as originally assessed.
“That came as a great problem for us and investors,” says Holm, “but we believe that the tender struck a good balance.”
After losing the favourable equity treatment for the Tier 2 securities, Danske in September 2013 launched a tender offer for the bonds, achieving a 90% participation rate. In the meantime, it had launched a new Tier 2 issue, a Eu1bn 10 non-call five, and in November and December last year the bank was busy raising Tier 2 capital in Nordic currencies, via a Dkr5.55bn equivalent five tranche deal dubbed “Trekroner” for targeting the three Nordic currencies, and then in Swiss francs.
“The bulk of our Tier 2 issuance is in place for now,” says Holm. “There may be some further issuance in 2014, but not of the same size as in Q3 and Q4 2013, and more for small adjustments only.”
Instead, the main target from a debt capital perspective is AT1 issuance, which the issuer initially had hoped to be able to execute in the autumn of 2013 but decided against pursuing because it wanted more clarity on the tax issues.
However, a benchmark-sized AT1 issue is on the issuer’s agenda for this year. Danske will keep its options open with respect to the currency of such a deal, according to Holm, but has a preference for euros, while in terms of the structure it has been focussing on a temporary write-down mechanism.