It looks like Austria has one more thing to worry about: The Basel banking reforms.
Part of the Committee’s proposals to `purify’ common equity Tier 1 capital for banks involves excluding minority interests from the regulatory measure. This is not a good thing for many banks — but there seems to be a particular consensus forming that this is an especially `not good thing’ for Austria’s banks.
Here for instance is Bank of America Merrill Lynch’s Cristina Marzea:
An automatic implementation of these proposals suggests the Austrian banks alongside SA and Israeli may be most impacted. For the Austrians, an automatic implementation would hurt Erste given its high level of minorities of E3.4bn, mostly for the Austrian savings banks (c E2.5bn), with BCR minorities of some E400m. For Erste the consolidation of the Austrian savings banks adds cE50bn of assets and E24bn RWA, c20-25% of group RWA.
While we see the logic where regulators want to take a harsher stance on minority treatments (lets face it, it is only in theory that minority capital in a foreign subsidiary is usable to plug capital deficits elsewhere within the group), we believe in this particular case a very strict interpretation of the rules may force Erste to rethink its options with respect to legal structure alternatives. Again, automatic number crunching suggests Erste’s core equity Tier 1 (without government participation and minorities would be at 4.05% and 5% in 2009e/2011e, rather than our forecast of 6.7% and 7.3%.
Excluding cE1bn of minorities from Raiffeisen’s Core Tier 1 but fully consolidating the assets would take some 1.7-2% off the Core tier 1 as well, taking our 2009/2011e forecasts from 7.9%/9.1% to 6.2% and 7%, respectively.
A sentiment echoed by Citi’s Simon Nellis:
Basel 3 —New proposed Basel rules released yesterday seek to 1) raise the quality of regulatory capital, 2) strengthen capital against counterparty risk, 3) reduce system leverage, 4) reduce the procyclical nature of prudential regulation, and 5) strength regulation of liquidity. Of the initiatives to increase the quality of regulatory capital the one that is most worrying for the Austrian banks, in our view, is the recommendation to deduct minority interest from tier 1 capital.
* Erste — Erste Bank screens poorly vis-à-vis its European peers with a relatively low 2009E core equity tier 1 capital ratio (credit risk) of 7.3% (ex. participation capital) estimated for end 2009 (including part. cap. the core equity tier 1 ratio moves up to a more solid 10.1%). Moreover, minority interest accounts for c 30% of tier 1 capital; deduction of minority interest would thus bring the core equity tier 1 ratio (ex part. cap.) to an estimated 4.2% and the stated tier 1 ratio to an estimated 7.0%. Erste Bank’s large minority interest (€3.4bn as of end 3Q09) stems from the bank’s cross guarantee arrangement with the Savings Bank sector in Austria (Erste has management control and thus fully consolidates the sector but does not own controlling stakes in most of the sector). Should the regulator ultimately require the bank to deduct minority interest we think the bank may explore the possibility of deconsolidating the Savings Banks while not dismantling their cooperation. Erste has indicated that on a proforma basis its capital position would improve slightly post a theoretical deconsolidation.
* Raiffeisen International — Raiffeisen International (RIBH) screens relatively well with a 2009E core equity tier 1 ratio of 8.2% (including market risk and ex participation capital) (including participation capital this ratio improves to 9.1%). The risk is more indirect as the deduction of minority interest would have a material negative impact on the capital position of its parent, RZB. RZB had a core equity tier 1 ratio of 8.3% (including part.cap.) and 5.7% (ex part. cap.) as of end 3Q09. A deduction of minority interest would push down RZB’s core equity tier 1 ratio (ex part. cap.) to 3.9% and RZB’s stated tier 1 ratio to 6.6%.
* Push Back — We expect significant push back on the issue of deduction of minority interest from many European banks as a number of other cooperative banks should also see their capital ratios deteriorate significantly should this measure come into force; indeed the Italian regulator already issued a statement indicating that it foresaw that “consideration will be given to the possibility of partially recognizing minority interests in calculating the highest quality capital components“. The Austrian banks will also take some comfort from the BIS’ assurance that it will “put in place appropriate phase-in measures and grandfathering arrangements for a sufficiently long period to ensure a smooth transition to the new standards.”
Related links:
Basel blows out DTAs – FT Alphaville
The Basel III sell-off continues – FT Alphaville
Digesting the Basel reforms – FT Alphaville
Austrian CDStrudel – FT Alphaville