Has Fitch Ratings just given the hybrid capital market one big boost?
On Monday the rating agency quietly issued an 800-word statement outlining why it “expects to be able to rate new generation bank hybrid securities” — which, conveniently enough, was also the title of the piece. It reads, as Gary Jenkins over at Evolution notes, “as much as a solicitation for business as an explanation” as to why their rating methodology will work for things like Contingent Convertibles (CoCos).
But here’s an extract:
Fitch has reviewed a number of the public comments submitted in response to the Basel Committee’s Consultative Document “Proposal to ensure the loss absorbency of regulatory capital at the point of non-viability” (August 2010) and notes that market participants continue to ask some fundamental questions regarding the future issuance of such instruments and in particular whether they are capable of being rated.
Fitch clarifies that it expects to be able to rate bank-issued hybrid capital instruments that conform to the proposal put forward in the Basel Committee’s Consultative Document, both with regard to conversion into common equity (so-called “CoCos”) or principal write-down and the inclusion of triggers based on regulatory discretion. Fitch’s existing rating criteria (“Rating Hybrid Securities” dated 29 December 2009) specifies Fitch’s analytical approach to such instruments.
The Basel Committee’s consultation paper “proposes to ensure the loss absorbency of regulatory capital at the point of non-viability”. Under this proposal the trigger event for loss absorbency is defined as the earlier of:
“(1) the decision to make a public sector injection of capital, or equivalent support, without which the firm would become non-viable, as determined by the relevant authority; and
(2) a decision that a write-off, without which the firm would become non-viable, is necessary, as determined by the relevant authority.”
Fitch considers this “point of non-viability” to be closely analogous to the point of “failure”, the risk of which is expressed in Fitch’s bank Individual Ratings. These ratings attempt to assess how a bank would be viewed if it were entirely independent and could not rely on external support. Individual Ratings are designed to assess a bank’s exposure to, appetite for, and management of risk, and thus represent the agency’s view on the likelihood that it would run into significant financial difficulties such that it would require support.
Of course, the Fitch statement doesn’t really address some of the other ratings issues expressed by Standard & Poor’s and Moody’s. Moody’s for instance, was worried about how it would be able to analyse the ability of a ‘host’ bank to absorb losses resulting from any CoCo conversions — in addition to the trigger points.
Still though — where one rating agency goes others often follow.
So Fitch’s CoCo-salvo could well help clear one of the stumbling blocks for a proper CoCo market should Moody’s and S&P follow suit. A word of warning for potential investors though — CoCo ratings could well end up being volatile.
From the Fitch statement:
Fitch recognizes that this is an evolving topic and that clarifying standards for hybrid securities – Contingent Convertibles in particular – remains an important goal for regulators worldwide. Our hybrid criteria is cognizant of this and mentions that our existing guidelines are likely to be subject to more exceptions and frequent changes than is normally the case with rating criteria.
CoCo *pops* anyone?
Related links:
Bail-in to Coco - FT video
European bank bail-ins will cost +87 basis points – FT Alphaville
BarCap’s CoCo comeback – FT Alphaville