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Bank Capital Clarity?

25 November 2016 by Gary Kirk

Yesterday morning the European Commission released a series of amendments to CRD IV, which some observers are calling CRD V. The overhaul has been many months in the making and is not expected to be complete until the end of Jan-17 but some of the issues announced yesterday have clarified a number of well-discussed points that should be well received by the investor community. It is worth highlighting the most salient points, which support our earlier views that the deeply subordinated banking sector offers some of the most attractive returns available in fixed income, and these latest changes merely endorses that view.

The key points in our view (greatly summarised) to the proposed CRD IV changes are:

a) TLAC (total loss absorbing capital for G-SIBs) has effectively been merged with MREL (minimum requirement for own funds and eligible liabilities). MREL allows for a 4yr phase-in period from 2016 and under the new changes the EC proposes a new class of non-preferred senior(?), presumably because the Regulators require G-SIBs (globally systemically important banks) to meet their MREL thresholds with subordinated debt.  As a general rule of thumb, MREL will be set at twice the minimum statutory capital requirement for banks.

b) AT1 issues will have statutory dividend stoppers introduced, although this applies only once a bank has entered its MDA (minimum distributable amount) zone. If a bank does enter its MDA then AT1 coupons must be paid before bonuses and share dividends.

c) Where a bank has breached its MREL requirements it has a 6-month grace period on AT1 coupon restrictions.

d) There are no significant increases in capital requirements.

e) As, expected and as we reported some time ago, Pillar 2 capital is split between P2R (requirement) where the MDA takes effect and P2G (guidance) which can be breached without any distribution restrictions.

f) Minimum leverage is set at 3% – as yet there is no introduction of any leverage buffers.

g) Any AT1, Tier 2 or MREL bonds that have been issued out of special purpose vehicles or under foreign-law will lose their capital benefit, after the first call date.

In the past many critics of the AT1 (coco) market have pointed to the structures being too equity like in their character – these new announcements, in our view, have created a clear distinction and highlight the relative value in this high yielding product.

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