It is a lonely time for hybrid capital. While uncertainty around new structures is stifling issuance, regulators and investors are increasingly focused on common equity as the best way to measure bank strength.
That was reinforced last month when the European Banking Authority called for banks to hold 9% core capital — although the EBA did say it would let a special, soon-to-be-unveiled convertible hybrid instrument into the mix.
Banks have responded to the regulatory pressure in a big way, with a stream of offers to buy back hybrid capital at levels far below par. The logic seems simple. These old-style hybrids will start losing capital treatment from 2013, so it may seem obvious to take advantage of heavily depressed prices now to book a few dozen basis points of core capital.
Simple, but short termist. Core capital is in the spotlight now, but it won't always be.
One obvious obstacle ahead is the leverage ratio. This often overlooked cousin of the standard risk weighted asset-based capital ratio will measure tier one capital as a proportion of total exposures. Basel calls for a 3% ratio along these lines, but at this stage the measure is in a testing phase.
With banks not required to report their leverage ratios until 2015 — and no concrete requirements likely to come into effect until three years after that — it is easy to see why it is being overshadowed by core capital concerns today.
Granted, capital credit is being phased out on existing tier ones, and by 2018 today’s hybrids will provide just 40% of the tier one credit that they do today. But some back-of-the-envelope calculations show why it is still worth considering whether holding a hybrid might make more sense.
A bank that buys back €1bn of hybrid debt at 70% of par today would add around €300m to core tier one levels immediately. That’s clearly attractive. But it is not obviously more attractive than holding on to it. In 2018 the hypothetical instrument would still add €400m to hypothetical tier one capital, with the remainder likely to spill into tier two.
That is not insignificant. And once you consider that coupons on these pre-crisis instruments are typically unbelievably cheap by today’s standards, the whole picture looks much less black and white.
It is a tough time for bank treasury teams as they negotiate the obstacle course of regulations. But they must not lose sight of long term goals in the struggle to get ahead today.