Updated — We’ve added a bit more on how the EBA might treat convertible bonds as part of the capital targets. Also see the FT’s reporting on the issue.
The key chart from the European Banking Authority’s release late on Wednesday night (featuring as its target the widely trailed 9 per cent Core Tier 1 capital rato for banks):
First, watch those footnotes! Like a list of the banking damned:
(1) A substantial part of this amount is attributable to Volksbank Group and should be considered as pro-forma. This group is currently under deep restructuring and evaluation of its business model after which Volksbank Group shall end up in a regional active bank.
(2) This amount, which is attributable to Dexia Group, should be considered as pro-forma. After the cut-off date of 30 September, this Group has indeed been deeply restructured through the sale of Dexia Bank Belgium to the Belgian State for 4 bn euros while a state guarantee is hitherto provided on the funding issued by Dexia SA and its subsidiary Dexia Credit Local. Furthermore, other disposal of important operating entities will take place in the coming months.
(3) The capital package for Greece has been defined in such a way not to conflict with pre-agreed arrangements under EU/IMF programme. This assistance programme already defines a set of targets for the banks in question, including quantitative objectives for the Core Tier 1 ratio, which are being monitored on a regular basis. The existing backstop facility (30 bn Euros), exceeds the results of the EBA capital exercise for Greek banks.
And also watch out for this big caveat from the methodological note:
The EBA estimated the preliminary impact of this approach (as per banks’ communications to the market) according to June 2011 data. In particular, banks were requested to provide to the EBA:
- The capital position as of end June 2011;
- The sovereign exposures as of end June 2011.
However, September 2011 market prices have been used for the valuation of sovereign exposures as well as for estimating the amount of prudential filters on sovereign AFS assets. Internal EBA proxies, based on bond yields, have been used when the overall value-adjustments on HTM and Loans and receivables portfolios estimated by banks were lower than EBA’s estimates.
The final total target buffer will be based on September 2011 data, and is expected to be published in the course of November. At this time banks estimates and EBA’s benchmarks will be compared at the level of each sovereign and the higher taken.
In computing the preliminary figures, banks have been allowed into take in consideration significant events (capital injections, de-leveraging, restructuring) occurred between June and September 2011. These figures are not audited, have been provided by banks on a best effort basis and have not been checked by the EBA. Furthermore, at this stage, no check has been carried out on the eligibility of capital instruments and appropriate implementation of CRD3 provisions.
Actual amounts according to September-end 2011 data will therefore differ from the preliminary estimates published today on the basis of June 2011 exposures.
Moving on, two more points that jump out immediately:
- It looks like complex hybrid capital such as the German Landesbank silent participations will be counted. Banks will be allowed to issue private contingent instruments towards their capital targets (though according to the EBA, on a strictly defined basis).
- The EBA uses “filters” based on market prices to decide the capital holes that need to be filled vis-a-vis sovereign debt. The filter for the bonds held to maturity by banks is described thus (we’ll concentrate for now on the “bufferHTM”, though there’s separate and complicated treatment of sovereign debt held available for sale):
Banks have been asked to carry out a conservative valuation of the EEA sovereign exposures booked in the HTM portfolio and loans and receivable portfolio, making use of existing market prices as of September 2011 and current bond yields by maturity as a reference for loans and non traded assets. Banks’ assessment has been used for computing the buffers, with a floor set according to the EBA’s own calculation based on bonds yields, sovereign by sovereign and maturity by maturity, for a basket of government bonds. The maturity buckets are the same employed in the EU-wide stress test (3 months, 1 year, 2, 3, 5, 10 and 15 years).
More as we delve into the data and methodology. Meanwhile, here’s a Q&A from the EBA on the whole thing, including some sharp responses on the whole matter of deleveraging assets to improve capital ratios.
Updated — So, how far can convertible bonds be counted as part of capital-raising? Reuters reports that Spanish lenders will be able to apply €9bn of such bonds to their targets. They hadn’t been able to include this kind of debt during the original EBA stress test in July.
From the EBA Q&A:
Why did you decide to accept newly issued private contingent instruments in the capital buffer?
Since the EU-wide stress test, the sovereign situation has deteriorated significantly thus calling for exceptional buffers to be set aside. Since buffers are intended to absorb potential (contingent) losses, new private contingent convertibles might be considered eligible under very strict and fully harmonised criteria. These instruments should be fully funded and structured consistently which will be defined in a common European term-sheet that the EBA is finalising. Existing convertible capital instruments will not be eligible unless they will be converted into common equity by October-end 2012.
They still need to work on what the bonds look like, basically.
How can the EBA ensure that only strong convertible instruments are included in Core Tier 1 capital?
Private contingent convertibles should be fully funded and meet strict criteria set out in a common European term-sheet that the EBA is finalising.
No really, they’ll get back to you.
There’s another sidelight here (from the methodological note) that might ring alarm-bells, given the original EBA stress test’s allowing sovereign support schemes for banks:
The definition of Core Tier 1 is the same used in the 2011 EU-wide stress test (including existing capital instruments subscribed by governments). This definition of capital comprises the highest quality capital instruments (common equity) and hybrid instruments provided by governments as announced by the EBA for the 2011 EU-wide stress test.
…
This means, in particular, that the commercial instruments included in Core Tier 1 have to be simple, issued directly by the institution itself and able, both immediately and without any doubt, to meet the criteria of permanence, flexibility of payments and loss absorption in going concern situations. The inclusion of government support measures in this definition reflects the expectation of supervisors that those instruments will be fully available to absorb losses and shelter banks in case of difficulties.
Related link:
Leaders struggle for eurozone deal – FT