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Bank Capital | July 2015 | 1

BANK CAPITAL 2015

2 OVERVIEW Banks desperate to see the final act in post-crisis capital

4 THE REGULATORS The view from the top

6 TLAC / MREL A quantum, for solace: how much capital needs to be raised?

9 BANK CAPITAL ISSUERS’ ROUNDTABLE Seeking the best solution as regulators move the goalposts

19 PRIMARY MARKET UPDATE Banks await final orders with markets open for business

21 AT1 MAP European AT1 landscape: overview of structures

22 INSURANCE CAPITAL Insurers finally come face to face with Solvency II

24 BANK CAPITAL INVESTORS’ ROUNDTABLE Confronting shifting sands of bank capital risks

34 THE AT1 INVESTOR BASE A volatile asset class? Get real

36 AT1 SURVEY Polling the AT1 investor base

38 RATINGS Waiting for the captial raisings and recovery regimes to pay off

40 LIABILITY MANAGEMENT Sitting on their hands

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001 Contents Bank Cap.indd 1 06/07/2015 08:59

2 | July 2015 | Bank Capital

OVERVIEW OVERVIEW

THE BIGGEST CORPORATE collapses in the 21st century have tended to produce two things — regula-tion and movies. Enron spawned The Smartest Guys in the Room and the Sarbanes-Oxley Act. Lehman Broth-ers has been rather more prolific. So far it has provided source material for the Oscar-winning Inside Job, the Oscar-nominated Margin Call, and the not Oscar-nominated Too Big to Fail, which featured a very beardy performance from Paul Giamatti as former Federal Reserve chairman Ben Bernanke.

Its regulatory legacy, though, is still in the cutting room. Lehman’s demise can already be credited with Basel III, the USA’s Dodd-Frank Act and Europe’s CRD IV, and it will soon chalk up the next challenge for the world’s biggest banks — total loss-absorbing capacity, or TLAC.

When the Financial Stability Board in November unveiled its TLAC pro-posals, which require the global sys-temically important banks (G-SIBs) to hold bail-inable instruments equivalent to between 16% and 20% of their risk-weighted assets, it betrayed the ultimate goal of post-crisis banking regulation.

The FSB said the rules would address the “recapitalisation capac-ity” of banks. If Lehman proved any-thing, it was that if a bank was to fail on a Friday without cost to the tax-payer, it had to be raring to go as a via-ble institution by Monday.

“It is all about resolution now, not liquidation,” says Jackie Ineke, head of European financials credit research at Morgan Stanley in Zurich. “TLAC is now more important than capital to a great extent. In most cases as a bond-holder you will be resolved before liq-uidation is even thought about. That bank needs to be incredibly well capi-talised going into the next six months of its life post the resolution weekend.”

The FSB’s 16% lower level comes from the 8% minimum capital require-ment imposed by Basel III across core

equity, additional tier one and tier two, and then another 8% to replace that capital, which is assumed to have been completely wiped out in a resolution.

Banks are being forced to hold capi-tal for two adequately capitalised insti-tutions: the one they are now, and the reincarnation that will emerge should they run into trouble. Bail-ins not bail-outs. Resolution not liquidation. These are the placard slogans of contempo-rary banking regulation.

The final act?The final TLAC rules are due to be presented at November’s G20 Lead-ers’ Summit in Turkey. The European Banking Authority will then unveil its own version, the minimum require-ment for own funds and eligible liabili-ties (MREL), by the end of the year, enabling national regulators to sit

down with every European bank and give them a final number for total capi-tal. This should be the final piece of the post-crisis capital puzzle for banks, which have had to raise eye-water-ing amounts already, largely via loss-absorbing instruments that didn’t exist only a few years ago.

“We now have a much better defini-tion of what the end state is going to be for bank capital,” says William Chalm-ers, global co-head of financial institu-tions group at Morgan Stanley.

“On the back of that, banks have been much more engaged with mov-ing towards their ultimate capital need,

beyond equity. We have also seen the remarkable development of a market for loss-absorbing instruments, par-ticularly AT1. Five years ago there were a lot of cynics as to whether the market for that product would ever really open up. Here we are now and people are making it one of the core pillars of their capital base.”

With the regulatory capital structure now all but settled and with the vast majority of institutions given a clean bill of health in the European Cen-tral Bank’s stress tests late last year, banks can start to look forward to a time when the capital ratios slide can assume a less prominent role in their investor presentations.

Concern for the collective creditwor-thiness of the European banking sector in the last few years has eased, helped by deleveraging and with another €85bn plus of AT1 and tier two issu-ance in 2014, according to Morgan Stanley figures.

It was not so long ago that investors drew much comfort from rapidly ris-ing capital buffers, pushing the com-mon equity tier one ratio to page one of many quarterly results presentations in 2011 and 2012, and setting Europe on a path to having nine institutions with a total capital ratio of 20% or more by the first quarter of this year (see chart on page 3).

“Banks that previously prided them-selves on premium capital levels are now accepting that they should ‘just’ be managed to regulatory expecta-tions,” says Chalmers. “They are now operating in line with others as banks are all being brought up to the same level.”

Banks are on schedule with the foundations. Now they have to worry about what the house is going to look like. “Among other things, banks are focused on getting back to being dividend paying stocks,” says Claus Skrumsager, co-head of global capital markets EMEA at Morgan Stanley.

“At some point investors will penal-

Banks have cleaned up and found an investor base for billions in new age loss-absorbing capital, but with regulators putting the finishing touches to the post-crisis framework, there is no shortage of challenges ahead, writes Tom Porter.

Banks desperate to see the final act in post-crisis capital

“Any impression of stability is perhaps a little illusory, and we

are still some time away from seeing

the full picture emerge. We have a

rock solid house built on shifting sands.”

William Chalmers, Morgan Stanley

002-3 Overview.indd 2 06/07/2015 09:00


OVERVIEW OVERVIEW

ise banks for holding too much capital. The question then is whether you use that capital to invest in more profit-able business or do you give it back to shareholders.

“That is why stock buybacks and dividends are still a regulation deter-mined activity right now. Regula-tors want to see further stability, big-ger cushions, business models fully entrenched and understood and then we will hopefully get back to normality on dividends.”

TLAC tormentThe era of fear and uncertainty may have passed. But the safety measures put in place by regulators have caused a tectonic shift in the mindset of lend-ers. With living wills, bail-in and now TLAC, they have to think first and fore-most about how to pay for their funer-al, rather than simply trying to make money while they are alive.

“As bank capital managers we always think in going concern terms,” says Erik Schotkamp, head of capital man-agement and long term funding at BBVA. “We don’t think about dying, we think about complying at the low-est cost and in the most transparent way we can to lower cost. But that is not necessarily consistent with the goal of thinking about your bank dying and having adequate capital to recapital-ise itself.”

One crucial question is whether bail-ins will be imposed on a multiple or single point of entry basis. This will have a material impact on internation-al banks like BBVA, which will all have to consider whether non-core busi-nesses will remain cost-effective from the capital standpoint.

Some argue this is the goal of regulators — to make the univer-sal bank model that became so loathed in the aftermath of the 2008 crisis too expen-sive for banks to oper-ate, and force lenders to be more region-ally or domestically focused.

It is also difficult to underestimate the impact TLAC is going to have on both bank capital issuance in the next few years and the creditor hierarchy

itself, particularly in Europe.Andrew Gracie, the man in charge of

resolution at the Bank of England, in a speech in December said that TLAC was intended to be “policy neutral for G-SIBs with or without holding com-panies”, as well as neutral in terms of bank structure or resolution strategy.

In practice, it is looking anything but. The US, Swiss and UK banks have a long established holdco-opco struc-ture, and some, such as Credit Suisse, have already ramped up issuance of TLAC eligible holdco senior.

But in continental Europe, where holdcos are expensive and legally chal-lenging to set up, TLAC has forced member states into unilateral action. Germany has drafted a law making all senior unsecured debt TLAC eligi-ble, leading investors to re-price Ger-man banks’ senior paper wider as they digest the new risk. Spain has taken a different approach, with legislation to give banks the option of issuing a new layer of ‘tier three’ capital, which would be labelled senior but contractually bail-inable.

For investors this takes bank capital even further away from the harmoni-sation they have been screaming for since the first AT1 trades were printed. With different solutions being applied across Europe, and with each coun-try having a national regulator whose interpretation of the resolution process could differ wildly to that of its neigh-bours, the time taken on each credit decision is only likely to rise further.

Parallel universeAnd there are some other pretty major plot twists for our protagonists still to negotiate. The Basel Committee on

Banking Supervision is scrutinising banks’ myriad methods for calculating risk-weighted assets and wants them standardised. Add in the fundamental review of the trading book, the leverage ratio and the persistent uncertainty surrounding banks’ Pillar 2 disclosures and it is clear capital requirements are still in their upward arc.

“The Basel risk weight consultation could prove very disruptive for banks’ capital planning,” says Alex Menounos, co-head of EMEA FIG DCM and head of EMEA debt syndicate at Morgan Stanley. “TLAC is currently viewed by many as the final missing link to defin-ing the capital structure, but a change in risk weight methodology could have a profound impact, in particular for banks with large mortgage and corpo-rate/SME portfolios.

“This is a significant potential head-wind for core equity as much as for the rest of the capital structure. In the near term, we may see some banks take a more conservative approach on CET1 by accumulating and building buffers to proactively manage any potential impact.”

In regulatory terms, this is another big year for bank capital. Early esti-mates suggested TLAC and MREL would mean another €500bn of loss-absorbing paper being printed.

Banks have a full range of proven instruments with which to get on with the job. But they are impatient to know what to use, and how much.

“The biggest win for the banks over the next 12 months would be a reali-sation on behalf of regulators that they have done enough and we are now approaching the endgame,” says Chalmers. “Right now, we are in a sort

of parallel universe where aspects of the post-crisis capital regime appear to be getting close to set-tlement, but there are still a number of mov-ing parts, for example risk weights.

“Any impression of stability right now is perhaps a little illu-sory, and we are still some time away from seeing the full picture emerge. We have a rock solid house built on shifting sands.” s

Source: Morgan Stanley

10.5 11.9

10.511.3

10.111.2

12.713.8

10.510.5

11.514.1

10.213.8

14.115.6

16.613.6

13.418.6

20.521.1

1.0 0.0 0.8 0.0 2.4 1.7 0.00.8

0.0 0.81.8

2.1

3.1

2.70.4

2.02.3

2.4 3.5

1.4

2.63.7

1.2 1.4 2.8 2.9 1.92.8 3.1

1.2

5.35.4

3.7

2.26.5

3.55.6

2.82.3

5.35.7

5.93.1

3.3

12.7 13.3 14.1 14.2 14.315.7 15.815.8

15.816.7 17

18.419.8 20 20.2

20.3 21.1 21.322.6

25.926.2

28.2

0

5

10

15

20

25

30 %

BNP

Santander

UniCre

d

CMZBK

SocGen

HSBC

BBVA DB

Erste

StanChart

RBS

Danske

CASA CS

ABN

Nordea

SEB

Rabobank

Lloyds

UBS

Swedbank SHB

CET1 Tier 1 Tier 2 CET1 FLT

Selected European banks’ capital ratios, targets and leverage ratios

002-3 Overview.indd 3 06/07/2015 09:00


THE REGULATORS

Mark Carney, chair of the Financial Stability Board, governor of the Bank of EnglandOn TLAC, November 2014:

“Agreement on proposals for a common international standard on total loss-absorbing capac-ity for G-SIBs is a watershed in ending ‘too big to fail’ for banks. Once implemented, these agree-ments will play important roles in enabling globally systemic banks to be resolved without recourse to public subsidy and without disruption to the wider financial system.”

Andreas Dombret, member of the executive board, Deutsche Bundesbank, co-chair of the Financial Stability Board’s regional consultative group On bail-in, April 2015:

“To allow even large banks to fail we have to build a viable resolution regime. Such a regime would allow these banks to fail without disrupting the entire financial system. They would be able to fail in line with market principles and in an orderly and predictable fashion. The ulti-mate ‘entrepreneurial burden’ would be shifted from the taxpayer to banks — and that is the right thing to do.

“The BRRD also sets out a clear hierarchy for the bailing-in of owners and creditors. Starting in 2016, bail-ins will become mandatory for failing institutions in the EU. Bail-ins are in and bail-outs are out, so to speak.”

On Cocos, February 2015:

“Now is the time for supervisors to develop a code of best practices for issuing Coco bonds. While taking national legal systems into account, we supervisors need to strive for as much standardisation as possible in order to achieve conver-gence in the EU. It is important, though, that Coco bonds actually be used to absorb the losses that the issuing banks could potentially incur.

“This challenge has been recognised by EU lawmakers and supervisors. The key tasks facing supervisors now are to observe the market very closely and to press ahead with efforts to improve the legal framework for Coco bonds. Once these tasks have been accomplished, Coco bonds can be a useful addition to banks’ capital structure. By helping to strengthen the capital base, they will make an added contribution to enhancing banks’ resilience to future crises.”

Danièle Nouy, president of the supervisory board (Single Supervisory Mechanism), European Central BankOn sovereign risk weightings, April, 2015:

“It was confirmed during the crisis that there are no risk-free assets, so there should be a risk weight, capital requirements for sovereign exposures.

“I’m not looking for a revolution and a particularly high risk-weighting. In many cases, these are good quality assets. First and foremost, we need to acknowledge that government bonds are not risk-free. Making that clear in the regulation would be a strong signal. And such a signal is more important than the amount of capital required to be held against the bonds.”

The following quotes have been extracted from speeches or press statements made by senior European policymakers and regulators in 2014 and 2015. These quotes were selected to provide a high level overview of the direction of travel for bank capital, TLAC, resolution and bail-in.

The view from the top


THE REGULATORS

Andrew Gracie, executive director, resolution, Bank of EnglandOn TLAC, December 2014:

“Perhaps the most significant of the requirements regarding the quality of TLAC relates to subordination. This comes down to the question of credibility of bail-in.

“And there is a concern about No Creditor Worse Off (NCWO). Generally, senior debt (e.g. sen-ior bonds or securities), in a senior class, is a very small proportion of the class. And a lot of the other liabilities in that class are either difficult to bail in or cannot be bailed in without impair-ing critical functions. If we are relying on senior debt but not these other senior liabilities to absorb loss, then we would have to depart from the principle of equal treatment of equally rank-ing liabilities, and we might well quickly hit an NCWO constraint given that, in insolvency, loss-es would be spread across the class as a whole.”

On holdco/opco, December 2014:

‘’In a holding company group structure, only if the capital resources and other TLAC-eligible liabilities issued by the subsidiary were insufficient to meet losses and recapitalisation needs, would there then be a need to look at bailing in sen-ior liabilities in the subsidiary.’’

Piers Haben, director of oversight, European Banking AuthorityOn Pillar 2 and the supervisory review and evaluation process (SREP), May 2015:

“Under Pillar 2, the SREP is meant to capture all risks, governance and risk management and controls aspects…

“…One fundamental premise for the EBA work on SREP is the need to ensure a level play-ing field and convergence of supervisory practices and comparability of supervisory outcomes across the whole Union…

“…For the first time we have clarified that additional capital requirements (Pillar 2 require-ments) that we call Total SREP Capital Requirement (TSCR) should be seen as a binding requirement below the combined buffer requirements, and that should be met by the same quality of capital instruments as the minimum capital require-ments.”

Stefan Ingves, chair of the Basel Committee on Banking Supervision, governor of the Riskbank and chairman of the executive boardOn sovereign risk weights, May 2015:

“We should continue to be mindful of the inherent bias towards making things too complex. That is not to say that things should be simplistic, but making things complex is not always the best way to capture risk.

“…I think we can all agree that there is no such thing as a risk-free asset. When we talk about this issue we talk about ‘sovereign risk’, not about ‘sovereign risk-free’…

“…For this reason the Committee will consider potential policy options related to the exist-ing treatment of sovereign risk. It is important to note that this review will be conducted in a careful, holistic and gradual manner.”

Sabine Lautenschläger, vice-chair, supervisory board of the Single Supervisory Mechanism, executive board member, European Central BankOn national regulatory discretion, March 2015:

“Up until now, Member States in the euro area, banks and supervisors have to work with more than 150 different options and national discretions in the single rulebook.”

On harmonisation, March 2015:

“By harmonising supervisory practices, we will contribute to a level-playing field which will eventually also foster growth.”


TLAC / MREL TLAC / MREL

Less than a year ago, a dread spread among bankers as word went around that the Financial Stability Board, the international body established to assess vulnerabilities in the glob-al financial system, might propose that banks hold as much as 16%-20% of risk weighted assets in total loss absorbing capacity (TLAC).

The rumours became reality in November 2014, when the FSB released its initial terms sheet on TLAC.

Issuers and investors alike, how-ever, are still pining for more clarity from regulators on both TLAC, which will be finalised in November when the G-20 meets in Antalya, Turkey, and the Minimum Requirement for own funds and Eligible Liabilities (MREL), which will apply to all Euro-pean Union banks and will come into force in 2016.

Regulators have stated that they intend the two rules to be compatible, but discrepancies and ambiguities abound within and between them both. That has resulted in a vast spectrum of views on how banks working in different jurisdictions, with different business models and different structures, will be able to satisfy requirements without putting themselves at a compet-itive disadvantage.

The stakes are harrowingly high. Estimates of TLAC issu-ance range from €200bn to as much as €1tr (according to one US banker) — if refinancings of legacy instruments are includ-ed — and implementation is set for January 2019. But banks still don’t know how much, referred to as the “quantum”, of each of a variety of different regulato-ry categories of capital and debt they need to issue.

Those banks that move last are likely to have to pay a pre-mium for the increase in sup-

ply, but those that try for an early start are in danger of compliance risk overcomplicating their liability structures and potentially alienating investors, or getting the wrong mix of capital and debt, thus suffering from either lower equity valuations or higher debt prices as a result.

Global, but not homogenousTLAC will apply to the 29 largest, most systemically important banks. But those banks span 11 different countries with varying laws, render-ing the implementation of homog-enous rules challenging. Of those banks, some are closer than others to having the answers they need.

Banks in the US and UK have long operated under corporation laws that allow their institutions to be set up

as parent holding companies (hold-cos) with operating company sub-sidiaries. Switzerland’s two largest banks, Credit Suisse and UBS, also have holdco/opco structures in place.

That structure allows banks to separate operational liabilities, held in structurally senior opcos, from TLAC-eligible senior unsecured liabilities that can be issued from the holdco level. Banks with hold-co structures in place have already begun issuing TLAC eligible debt.

Investors have taken notice“[The spread differential] stabilised around 20bp to 60bp,” says Cecile Hillary, co-head of financial insti-tutions group fixed income capital markets for EMEA at Morgan Stan-ley. “It has been as tight as 10bp or

wide as 70bp-80bp, depending on the institution.”

When it comes to holdco/opco differential, further differentia-tion is almost certain. Banks with larger, non-ringfenced activities including investment banking will have to pay a premium, for example, Hillary says.

“But a simple bank with no investment banking activities and low risk away from the core business of lending — for them there is an argument that the holdco/opco differential should be close to nil,” she adds.

Market players have argued over where in the capital stack holdco senior sits, with some say-ing the FSB’s proposal indicates that it is, in actuality, the most subordinated debt instrument a bank can issue.

But Hillary and others are san-guine that regulators are intent on respecting the capital hierar-chy.

“Issuers have been on the front foot with their regulators,” she says.

“Holdco senior should be

Banks across Europe are coming to terms with the severity of new capital regulations. The problem now is: what, exactly, are those terms? Graham Bippart reports.

A quantum, for solace: how much capital needs to be raised?

4.5%

1.5%

2.0%

8.0%

2x Leverage

Min.

CET1 Buffers

CET1 Buffers

TLAC RWA requirement

TLAC leverage requirement

CET1 AT1 T2 TLAC Buffers

16%TLACminimum

A B

A - Risk-weighted test - 16-20% of RWAs

B - Leverage-based tests - 2x minimum leverage ratio requirement

Building TLAC: the FSB’s requirements


006-008 TLAC .indd 6 06/07/2015 09:02


TLAC / MREL TLAC / MREL

downstreamed as TLAC capacity. And capital instruments, whether at the holdco or opco level, would be bailed in before senior instruments.”

With that uncertainly seeming-ly behind them, banks with holdco structures — and investors in those banks — should be well positioned to meet TLAC requirements.

A ‘going concern’ for European banksBut banks on the continent have bemoaned TLAC’s “Anglo-Saxon” bias, illustrated in the exclusion of operational liabilities, like deriva-tives and corporate deposits, from bail-in eligibility.

Most European banks are struc-tured as opcos, their senior unse-cured liabilities ranking pari passu with operational liabilities. And since the most recent TLAC proposal only recognises as eligible opco sen-ior equal to a maximum 2.5% of risk weighted assets (RWAs), the options for compliance look expensive.

“Effectively, we are being told to issue tier two, which is a massive cost,” said Waleed El-Amir, head of group strategic funding at UniCredit, at an industry conference in June. In its February reply to the FSB’s con-sultation on TLAC, the bank said that under the proposal, Europe-an banks would have to deleverage, form holdcos or issue “gone concern” subordinated debt like tier two, all of which would come with the risk of “seriously jeopardising [banks’] capacity to finance the economy” due to their expense. It would, ironi-cally, also force largely deposit fund-ed institutions such as Holland’s ING, to increase leverage.

Germany’s government became the first to try to tackle the prob-lem in March, when it introduced a bill to statutorily subordinate sen-ior unsecured debt from operational liabilities. That would allow German banks — of which Deutsche Bank is the only Global Systemically Impor-tant Bank (G-SIB) — to use existing senior unsecured debt to meet TLAC requirements.

It could also help resolution authorities to resolve smaller banks without falling foul of the EU bank recovery and resolution directive’s No Creditor Worse Off principle, which guarantees that, in a resolu-tion, no creditor would be worse off

than if the bank had been liqui-dated. Under the statute, senior unsecured holders could no long-er claim they are pari passu with secured creditors.

“There’s a lot of interest in Europe to have a clean statutory approach like the one we are likely to have in Germany,” says Khalid Krim, head of European capital solutions at Morgan Stanley.

France, Spain and Italy, which have similarly strict corporation laws making it near impossible for banks to set up holding companies, are likely to follow in Germany’s footsteps if the approach proves suc-cessful.

But European banks in other juris-dictions are likely to contractually subordinate senior debt to opera-tional liabilities in their deal docu-ments.

Which means that European inves-tors, already relatively bogged down by the differences in contract law between European jurisdictions, are going to have to navigate an increas-ingly complex landscape for bank investment.

“It’s very surprising that [Germa-ny] took the step to change the law themselves and come up with their own solution for TLAC. I don’t think that was particularly helpful in terms of harmonising things in the mar-ket,” says James MacDonald, senior portfolio manager at BlueBay Asset Management.

Too much to manage (TMTM)?The complexity can only get worse. Beyond the holdco/opco approach taken by US, UK and Swiss banks, the statutory approach being pur-sued by Germany and contractual bail-in, TLAC provides for what the market has termed “tier three” — subordinated debt that sits between tier two and senior unsecured, mak-ing it a less costly option than tier two.

Many European banks are looking into the possibility, says Krim. Dan-ske Bank was reported in December to be thinking about tier three issu-ance, for example. The problem for some European banks is that many existing tier twos include contractual clauses that restrict issuers from fur-ther subordinating them after issu-ance.

“We have spent a lot of time with

many banks in Europe, doing due diligence on the existing documen-tation they have and looking at what kind of changes they can make today when they issue tier two, so that those instruments don’t carry restrictions or limitations for too long,” says Krim.

Some banks have found that they have the flexibility to issue tier three, others have already begun to make changes to their EMTN programmes so that new tier two issuance would provide them with the flexibility to layer in less subordinated junior debt, Krim says.

“Legacy tier two is grandfathered at the moment, but it is losing its CRD IV credit year by year. So, towards the end of the implementa-tion period, some banks with out-standing legacy hybrid tier one and tier two debt will be looking at liabil-ity management exercises to make their TLAC capital structures more efficient.

“If you’re a bank that will be in the market offering tier two in 2016 and 2017, this is the thing to think about right now,” Krim says.

Acronymic Agony —and then there’s MRELNational authorities will be charged with defining the Pillar 2, or non-binding, loss absorbing capital requirements on a bank by bank basis, and though there is little clar-ity on what will be needed to comply with those idiosyncratic standards, the rule will come into force in 2016, though with a phase-in period last-ing until 2020.

MREL’s known terms differ from TLAC in some major respects.

TLAC requires eligible senior unsecured liabilities to be subor-dinated — contractually, statuto-rily or structurally — to be bail-ina-ble and only recognises senior up to

“Between now and November there

will be an incredible amount of jockeying,

lobbying and push-ing in order to try and get a solution

that works on a local basis”

Waleed El-Amir, UniCredit

006-008 TLAC .indd 7 06/07/2015 09:02


TLAC / MREL

2.5% of RWAs, while MREL puts no limit or stipulation on eligible sen-ior unsecured. TLAC requirements exclude common equity tier one buffers for the RWA measure, while MREL includes them, as well as Pil-lar 2. Both TLAC and MREL can be expressed as a percentage of RWAs or as a multiple of leverage, but G-SIBs and Domestic Systemically Important Banks must hold 8% of their total liabilities and own funds in order to access resolution funds.

And while TLAC requires bank lev-erage ratios to be two times the Basel III minimum of 3% plus additional buffers, MREL requires it to be two times the “relevant” leverage ratio set by national regulators.

All of this spells confusion for bankers and investors alike. And though TLAC was initially thought to be the most onerous of the two, even that remains unclear.

“I’m not sure the TLAC require-ment will be more binding,” says Robert Kendrick, bank credit analyst at Schroders. “You may end up with more MREL.”

When Andrew Gracie, executive director of resolution at the Bank of England, gave a speech on the FSB’s thinking behind TLAC and its rela-tionship to MREL in December of last year, he said: “Our view is that there is no question about their com-patibility.”

But market participants are less clear that that is the case. The good news, Krim says, is that the indus-try is expecting the final versions of both rules to converge in important ways.

“When we speak to FSB repre-sentatives in Europe or to the EBA and European regulators, there is a strong desire to see the two converge, so that what applies to G-SIBs would apply to other European banks,” Krim says.

“I do think there will be a conver-gence of the TLAC and MREL pro-posals,” he says. “The EBA and the FSB have been working together to ensure this happens.”

Krim says that a broadening of TLAC’s eligibility requirements for senior is likely, as well as perhaps an increase in the 2.5% cap, to be more in line with MREL. And MREL’s lev-erage ratio and RWA tests are like-ly to converge towards the current TLAC proposal.

“The leverage ratio requirement will stay, since it’s seen by regula-tors as an alternative proxy to the risk weight calculations,” Krim says. With concerns from regu-lators over the disparity of risk weight calculations across banks, the leverage ratio will remain a focus.

It should also be a focus for investors. With the European Cen-tral Bank taking over as single supervisor of the eurozone’s banks — with direct responsibility for the 120 most significant groups — there is an expectation that internal RWA calculations will become more har-monised. Until then, the leverage ratio is key.

“In the interim, it makes complete sense for investors to look into lever-age ratios, especially because, at the end of the day, if a bank is going into insolvency or into resolution, the RWA [measure] is going to be noth-ing,” says El-Amir. “It’s actually the underlying liability that is going to be bailed in. That’s actually the value the regulator’s going to look at.”

Issuers, though, will still have to deal with both RWA measures and leverage ratio requirements, both yet to be set in stone. “The first step is that the regulators define and design the requirements. The second step is that banks raise the indicated quan-tum,” Krim says.

A quantum, for solaceAnd here is where the real balancing act begins. With TLAC and MREL, the distinction between funding and capital has all but disappeared.

“It’s completely changing the way issuers are thinking about capital versus funding,” Hillary says.

For banks, the issue will be large-ly one of satisfying senior investors that they are sufficiently buffered against bail-in, while making sure equity investors aren’t shouldering excess cost.

Once there is clarity on the quan-tum in 2016 or 2017, Krim says, “mar-ket participants will look at whether there is a benefit, i.e.: are equity and debt investors giving the banks cred-it for filling the regulatory demands? Is a bank’s response to its total capi-tal strategy and its answer to MREL well received by the market? Or should it adjust how it’s doing it?”

Equity investors aren’t now giving

credit to banks with higher capital ratios than their peers, Krim says.

“At the moment, we need to see how equity investors, on the one side, and debt investors, on the other, are either giving brownie points or penalising banks for going one way or the other. It’s too early to tell what the right answer is, but we don’t yet see anything in credit spreads or share prices that is linked to these regulatory developments.”

That may be because there sim-ply isn’t enough detail, yet. Investors could begin making discrepancies across banks when they have an idea of how loss given defaults compare across different capital strategies, something the vast majority of banks are still working on.

“There’s massive uncertainty,” says UniCredit’s El-Amir.

“Between now and November, when the final term [TLAC] sheet is expected to come out, there will be an incredible amount of jockeying, lobbying and pushing in order to try and get a solution that works on a local basis” across different jurisdic-tions in Europe, he says.

For that reason, Hillary says there should be no reason for banks to rush to begin filling their — as yet unknown — requirements.

“There is no rush to fill TLAC capacity by any specific date other than the 2019 deadline,” Hillary says.

Indeed, front-running final regu-lations could prove costly, since the right mix of debt and capital is going to be crucial to efficiency.

“What’s important is for banks to communicate to their investors what their capital and TLAC targets are when the numbers are clearer,” she says.

Whatever the outcome of the final rules, one thing is already very clear. The job of the bank treasurer has never been so complex. s

“There is no rush to fill TLAC capacity

by any specific date other than the 2019

deadline”

Cecile Hillary, Morgan Stanley

006-008 TLAC .indd 8 06/07/2015 09:02

Bank Capital 9

Bank Capital Issuers’ Roundtable

: Where do we stand in terms of the regulatory landscape at the moment? With TLAC and MREL are we seeing the final pieces of the post-crisis capital structure, or does more need to be done to allow issuers to finalise their capital strategies?

Khalid Krim, Morgan Stanley: If I look at where we are now in June 2015 we’re still waiting for some clarity on the regulatory side coming from the European Banking Authority on the minimum requirement eligible liabilities (MREL), and from the Financial Stability Board on total loss-absorbing capacity (TLAC). When we talk to banks and investors around Europe there is a high level of understanding of the direction of travel, though we’re missing some key details and clarification.

But clearly we have issuers now working on their total capital strategy. They are able to plan an issue, be it tier one or tier two capital, in the market and start to communicate to the investor community how the

resolution regime will work in their country, and how they think going forward they should be perceived as a bank.

2015 will be a year where we will continue to see banks implementing the CRD IV capital plan in tier one and tier two, and where we see more work being done to get familiar with the requests and expectations from the new supervisor, the ECB acting as Single Supervisory Mechanism (SSM).

The final pieces and the final judgment need to come by year-end but I think we’ve made significant progress.

: Erik, Rogier, could you give us an issuer’s view? With things as they are at the moment, how easy is it for you to get on with implementing a total capital strategy?

Rogier Everwijn, Rabobank: Rabobank has already been active in implementing the total capital strategy

Participants in the roundtable were:Leopold Bian, bank analyst, BlackRock

Rogier Everwijn, head of capital and secured products, Rabobank

Scott Forrest, head of capital strategy, Royal Bank of Scotland

Khalid Krim, head of capital solutions, EMEA, Morgan Stanley

Matthieu Loriferne, senior vice president of credit research, Pimco Europe

Alex Menounos, head of EMEA syndicate and co-head of EMEA FIG DCM, Morgan Stanley

Vishal Savadia, director, head of capital issuance and struc-turing, Lloyds Banking Group

Erik Schotkamp, head of capital management and long term funding, BBVA

Tom Porter, moderator, GlobalCapital

Issuers seek best solution as regulators move the goalposts

European banks have rolled up their sleeves and got on with the job of issuing loss-absorbing instruments to meet the new capital demands of Basel III, with another €80bn of capital printed across additional tier one (AT1) and tier two in 2014. AT1 accounted for 48% of capital volume in 2014 as banks made strides towards filling their 1.5% of risk weighted assets bucket. Still more banks have made debuts in the AT1 market in 2015 and many early issuers are expected to return to take advantage of cheaper pricing later this year.

Just as the post-crisis capital framework was settling down, the Financial Stability Board unveiled proposals to require banks to hold a new quantum of loss-absorbing debt equivalent to between 16% and 20% of RWAs. For issuers, the rules have been changed in the middle of the game. European jurisdictions have already revealed divergent plans to help their banks comply, and until the rules are finalised in November, issuers remain in the dark as to what they will have to issue by 2019.

Issuers and investors gathered at Morgan Stanley’s offices in London in June 2015 to discuss how to navigate the much altered route to capital compliance.

009-018 Issuers Roundtable.indd 9 06/07/2015 09:04


10 Bank Capital

since 2012 in preparing for the Bank Recovery and Resolution Directive (BRRD) when the crisis management directive was proposed — especially for the bail-in tool, because for us this was the most threatening part of the whole resolution package.

We started readying ourselves for operating at a total capital ratio of 20% initially, and our goal was to have that by year-end 2016. Since we were already above 21% by year end 2014 and with the TLAC proposals we have revised our target for year-end 2016 to mid-20s%. We will wait for the TLAC results to come out by the end of this year and then we can reset our target again for 2019, the introduction date for TLAC.

Erik Schotkamp, BBVA: If you think just about products like additional tier one, back in 2011 I remember sitting in this same sort of format with people from the EBA and banks were not believing this could fly.

That has now become a standardised product with a standardised term sheet. That took us four years. If I think about TLAC — and that for me is the next thing for us in terms of how we’re going to be managing this — that will take a lot of technical standards, a lot more than a CRD IV-compliant product because you need to talk about co-operation, implementation of BRRD laws in countries outside of the G20, convergence of regulatory standards; this is going to take a long time.

It’s a big thing for investors, talking to them, not knowing necessarily where they are or where they’re going to be or how they need to think about pricing and how this is all going to work.

I sense that Pillar 1, the base set core capital, tier two, AT1, most people know what they look like. There’s uncertainty on risk-weighted asset density, in the south of Europe we’re worried about Deferred Tax Assets and in the north of Europe we are worried about their mortgages in terms of risk-weighted assets.

But for me the really big thing going forward is how is TLAC going to turn out and what will I have to plan for. You can talk about material volumes but it’s how you have to fulfil it and what sort of regulatory co-ordination you need, which lacks a lot of clarity.

: What are investors’ main uncertainties around this new regulation, and have banks been responding in the right way?

Matthieu Loriferne, Pimco: We have more certainty at the bottom of the capital structure, be it common equity tier one (CET1) requirements or the various buffers. Everything is not clear but, as Khalid says, we have better visibility today.

If you move up the capital structure actually this is where the ambiguity lies and in particular regarding TLAC.

For us it’s more difficult to understand, not necessarily the target but how the banks are going to fulfil those requirements; what instruments they’re going to issue. Most important in our view is what would be the rights of bondholders and how are they going to be treated. Pimco fully understands the risks associated with investing in the new resolution environment, including that of being bailed in at the senior part of the capital structure. Understanding and recognising when those losses will happen and how the bondholders will be treated is what is most important to investors.

Leopold Bian, BlackRock: I agree that certainty

definitely has been a factor here at the bottom of the capital structure. You’ve seen that in the issuance of AT1 compared to tier two this year. There’s a big difference. Issuers aren’t going to rush out to print tier two until they have more clarity.

One thing I would add that still gives me a little bit of uncertainty is the SSM. I want to understand a little bit better how the whole SREP review process works and the interaction between the SSM and issuers.

From my perspective it feels that there’s not much that the SSM wants banks to disclose. Obviously you have some disclosure in a few countries but that’s something that still remains a lot in the dark. This is something I want more clarity on, on top obviously of TLAC and MREL, which depending on the issuer one should be more important than the other, but in any case it seems that we’ll get more clarity on this by year end.

Krim, Morgan Stanley: The SSM is trying to analyse and make sure that if there’s any Pillar 2 disclosure given to the market and to the investor community by banks, it is something which is methodology analysed. In the UK we had some disclosures and I’m sure Scott or Vish can comment on that in the context of the UK, their approach to Pillar 2a and Pillar 2b. In Europe we are behind and I think we still need to see what comes out in terms of a harmonised framework before any disclosure is made.

It’s only a couple of months that the SSM has been in place. Often when we speak to issuers they tell us they need to get to know the supervisor and understand the requirements. It’s a new supervisor so I think it will take a bit of time before we have this piece of information and clarity into the market.

: Scott, Vish, can you add anything on the Pillar 2a requirements in the UK?

Scott Forrest, Royal Bank of Scotland: Fundamentally from an issuer’s perspective if you are tasked with raising capital, raising secured funding or unsecured funding in the debt capital markets then you want to ensure that the dialogue you’re providing your investor base is the right type of information.

In that context the Pillar 2a disclosures are a welcome advance in the UK. From a bank’s perspective what you don’t want to be is an outlier. You want to ensure that in terms of disclosure you’re there as part of a pack. Otherwise from a markets perspective there can be some idiosyncrasies which will start to creep in.

Khalid Krim MORGAN STANLEY



Bank Capital 11

So as long as the disclosure’s done on a consistent, methodical basis, then it’s a fundamentally good thing, and one that we’re supportive of.

Vishal Savadia, Lloyds: I completely agree. Transparency is increasingly important for all issuers, particularly as we engage in our investor dialogue. Whilst the UK has been a front mover in terms of framework for Pillar 2 and disclosure provided by banks, what is clearly visible is that there continues to be significant differences in the framework between jurisdictions, either coming through SREP or some of the Pillar 2 requirements in other parts of Europe.

Those differences are becoming more apparent, which unfortunately again moves us away from the objective of trying to harmonise the regulatory framework which was, if we think back, one of the goals of Basel III. Its early form was a degree of harmonisation from which we seem to be moving away.

But at the same time where banks do have the ability to be transparent and provide that additional investor disclosure, that should be regarded as a positive step.

: Is this one of the things that investors are really pushing you for at the moment?

Savadia, Lloyds: It’s more that, as Mathieu pointed out, conceptually we know where we are and where we’re going in terms of the regulatory capital framework, we know the components of the capital stack and the regulatory objectives to migrate towards a TLAC/MREL framework. We all know the direction of travel, however calibration of the final framework is obviously the very important next step.

Additionally, how the regulatory framework will be applied is key. We have to remember, the purpose of items like TLAC/MREL is to try to improve the ability to stabilise a bank facing a severe stress over a weekend. This raises important questions, such as what is the subordination hierarchy, how might the different liability classes be treated in a stress scenario. It is items like this that we are getting more visibility of through regulatory dialogue but not necessarily through actual framework as yet. This is increasingly important and something the disclosure investors are requesting.

Alex Menounos, Morgan Stanley: Not so long ago we held a similar roundtable where we debated whether Additional Tier 1 would even work for some real money investors and what the capacity for such an instrument would be. Yes, we still face several headwinds with respect to the regulatory framework, the timelines and with respect to calibration, but fundamentally we know that we have the tools available to build the capital structure.

It is comforting to be in a position where we’ve seen a significant amount of the capital required already issued. Most jurisdictions have seen supply, and while some banks have yet to issue, they should take comfort in the fact that the market is there for them. I think it is important to acknowledge how far we’ve come.

Bail-in, MREL, TLAC are all big themes. I am not convinced there will be a harmonised solution across Europe. What we may eventually see is a mix of strategies, with some jurisdictions lobbying hard for a ‘German proposal’ approach, while others adopting a holdco senior or even a ‘Tier 3’ approach. We may even see different approaches within the same jurisdiction, as

some may favour issuing more own funds to fill TLAC requirements, while others explore potential efficiencies in creating a new bail-inable asset class.

: What are some of the other headwinds? TLAC is the most pressing issue but what’s next on the agenda, risk weights?

Menounos, Morgan Stanley: The Basel consultation on risk weights in my mind could be the next big topic.

Everwijn, Rabobank: I agree with you on the Basel IV proposals. At one end you had the improved quantity and quality of capital Basel III proposals, followed by BRRD basically avoiding taxpayers bailing out banks followed by TLAC — recapitalisation should be done by the buffers a bank is holding themselves resulting in elevated capital ratios. And that’s all fine if you have time to build up your ratios, a phasing in would be welcomed.

But if at the same time you are confronted with the asset side of the balance sheet, with risk weights pushed further north by basically compressing your total capital ratios, it makes managing capital ratios life really difficult.

Loriferne, Pimco: Before we move into Basel IV and risk weights there is another very important topic to discuss. It would be good to harmonise the definition of the CET1 ratio which still varies across different European jurisdictions. That is one of the key agenda items of Danièle Nouy, who chairs the SSM. She is currently working on harmonising and removing some of the national discretions. To me as an investor it’s a concern that at this stage of the regulatory agenda, the CET1 ratio from one bank might differ materially from another one despite being regulated by the same entity so before we get into the risk weight discussion, which obviously will take an enormous amount of time, it would be good to remove some of the biggest differences stemming from national discretions across Europe.

Bian, BlackRock: I totally agree with Alex that a lot has been done and if you compare, for example, what has been done in the banking space to the insurance space on the regulatory front, banks are way ahead. In the insurance space, Solvency II comes next year, and insurance companies are still submitting internal models for approval and they don’t know if they’re going to get approved or not. The

Rogier Everwijn RABOBANK



12 Bank Capital

implementation of Basel III and CRD IV seems very smooth compared to that.

Obviously there are a lot of moving parts in the regulatory landscape, but let me touch upon the point of RWAs. It’s absolutely fair to worry about it from an issuer perspective but investors should worry about it too. It’s crazy to think that AT1 securities for example have MDA or loss triggers that are reliant on a ratio whose denominator is going to change.

It’s very hard to look at Pillar 3 disclosures and see which banks are better prepared or which banks will suffer more from the RWA reviews that are being conducted. You can have an idea but you don’t know the quantum and that can be a very meaningful factor when thinking about what capital ratios will be in a year or two years’ time.

Forrest, RBS: But I think the other element from the UK context is ICB and how that will interplay with other regulations. You’re going to look at two separate entities, one of which would be ringfenced and one of which would be non-ringfenced as well. So all of these things coming together all at the same time do present a number of challenges in terms of how you’re going to solve for your capital position, and how you’re going to solve for your TLAC position, when there’re still a number of unknown variables in the equation.

Savadia, Lloyds: Before we get to the proposed changes in risk weightings, we’ve yet to see harmonisation of leverage requirements across Europe. The UK has again been a front mover in terms of setting leverage requirements but we’ve yet to see the consultation at the European level. Before we switch focus to the risk weight consultation, which remains very much a work in progress, it is important to get further clarity on items which we’ve been discussing for quite some time.

Krim, Morgan Stanley: We’re all waiting for harmonisation but the starting point is that we have a set of rules that are discussed internationally at FSB and Basel level. When it comes to implementation it can’t be one size fits all. When you look at the TLAC rules and you try and implement them in continental Europe I think it’s very different to trying to do that in the US, the UK or Switzerland. I think what issuers and investors are facing is a diversity in legal regimes across jurisdictions that aren’t enabling us to implement these rules in the same way.

I agree with Mathieu on that point, let’s at least harmonise CET1 before we move on to Basel IV and everything else. What is key is to make sure that we have banks that are adequately capitalised and better supervised. It’s easy to say but in practice that’s been happening in the last couple of years.

In terms of loss-absorbing capacity it’s not only the quantum, the race to the top as we call it, with people going to 20% plus on total capital. In my view, it’s more about how transparent you are in terms of your resolvability and how easy it is for investors to understand their position in the waterfall. When investors provide equity, tier one, tier two, senior debt to a banking group, where do you sit in that scenario?

Ultimately I could see a situation where a bank that is more transparent in terms of resolution planning, even if they have less capital than another bank in terms of quantum, may get better credit from the market, just because they will be perceived as being clearer

and transparency and disclosure should and will be rewarded in my view.

Schotkamp, BBVA: This is about transparency and the needs that investors have. I go back to the experience of the AT1s. You worry about disclosure on Pillar 2, you worry about RWA bases, lots of variables but on top of that what are you going to get is the maximum distributable amounts, and my coupon, where do I sit?

That dynamic has taken time for the investor base to get hold of and to model. The devil in TLAC is it is non-hierarchical, it doesn’t sit on top, it comes in between, before combined buffer requirements, and therefore it affects payments on the whole of the capital stack and non-compliance may even provoke core capital shortages.

As an investor, the amount of information you’re going to need on where that capital sits, how much each unit complies, what it can destroy, the variables you’re looking at in terms of disclosure and understanding are mind-boggling, I can tell you. We’re a multiple point of entry strategy firm, we’re trying to do the numbers and these things are exponentially more difficult to explain.

Given the importance of TLAC compliance you will have to start disclosing your maturity profile and your buffers. I don’t want to dramatise it but we have talked to competitors and they say for them it has strategic consequences. It will stop them doing certain businesses in certain countries because the whole thing becomes so enormously complex.

Maybe after all that’s the goal of politicians, maybe this is the squeeze the industry’s been subject to and it is about pushing people away from the business models that were built between the late 1990s and 2007.

Does it now make sense to be number five in a market 10,000 miles away from here with a regulator that doesn’t want to hear about TLAC and thinks we’re all nuts because there was no crisis?

It seems to be getting more complex rather than simpler. What happens to an overseas franchise in a resolution situation? Are we going to recapitalise it, are we going to let it drop? Can we defend that in Frankfurt or does the host regulator want to have a say?

Savadia, Lloyds: You’re absolutely right. What TLAC or MREL rules require banks to do is further explain their business strategy. Banks which should benefit are those which have a clear business model, with a low risk, less volatile and less complex group structure. Operating in fewer jurisdictions also helps as there are fewer areas

Erik Schotkamp BBVA



Bank Capital 13

that may attract additional capital and so on.That is where the focus should be. It is not only the

size of the capital stack and is institution X running higher capital levels than institution Y. More important in my mind, is getting comfortable with the level of loss-absorbing capital in institution X’s structure given its target operating model.

: As issuers, are you confident that you know what your respective regulators would do in a resolution situation, do you have a good enough idea of the process?

Everwijn, Rabobank: These are current discussions and to your point, Erik, they don’t care about the complexity of an organisation. They want you to make it as clean as possible in order to be able to resolve that company in a weekend; close on Friday and re-open on Monday. That is their ultimate goal and if the organisation starts to get too complicated they want you to make it easier.

Krim, Morgan Stanley: I agree with that, I think we need to keep it simple. Coming back to what Erik was saying, you referred to the time when ‘the bank is dying’. No one wants to plan their own funeral, but if you organise them it’s easier for people to manage them and reduce some of the pain associated to this process.

In our dialogue with regulators, we are seeing supervisors that are moving from the supervision side to the resolution side which is a good thing. They admit that they may not know all the banks but what they need to make it work is a manual to make sure that if there is a fire in the building if and when they come in, they know how to handle it, how to limit the impact on the building itself but also the buildings around it.

The TLAC term sheet you could say was simple, but I think the concepts and the implications of it are complex to implement so we will need a clear resolution strategy to complement and support the requirement for higher loss absorbing capacity.

Forrest, RBS: In terms of resolvability it’s not necessarily one model that will fit all banks. For those institutions viewed as being systemically important then yes, the recovery over the weekend and being able to come in and create a fresh start on Monday morning is there. But there will be some institutions that have less systemic importance and you could foresee circumstances where the regulator wouldn’t be so concerned, and in fact would just let them go over the weekend.

: Is it this kind of uncertainty that is causing fluctuations in holdco-opco differentials, for example?

Forrest, RBS: The holdco-opco differential really came into focus earlier this year, though for some issuers it had always been there. We took the decision to issue from holdco and for those earlier issuances there was discussion but it just depends ultimately on the dynamic of the market at the particular point in time whether there is a differential there or not.

You’ve seen a huge amount of volatility over the last few weeks so the differential between opco and holdco has bounced around significantly. It’s an investor’s prerogative to value any credit in whichever way they deem suitable.

That’s reflective of the position we are in whereby

we’re striving for harmonisation, and it’s been said a few times already, we’re falling short of that. We’ve got a number of differing models, there’s ultimately confusion there in the market and where you have that you’ll have volatility.

Savadia, Lloyds: Arguably the rating agencies are also a factor here. Inconsistency in recent frameworks hasn’t helped the market fully triangulate just where that holdco premium should be. To me it importantly comes back down to the view of the business and group structure.

: What would you like to see from ratings agencies? We don’t have one here but let’s assume that at least one of them will read it.

Savadia, Lloyds: They released their initial methodologies and then paused to let the regulation develop, which I think was positive. However, from the perspective of the UK you would like to see a degree of consistency in the application of ratings for similar ranking liabilities. For example, holdco loss-absorbing debt versus loss-absorbing debt from an institution without a holdco in place. It seems that capital issuance out of the operating company currently benefits from a ratings standpoint versus similar holdco liabilities despite them both being loss-absorbing instruments.

Such inconsistencies create uncertainty for the market and the investor community.

Bian, BlackRock: I agree with that last point. The rating agencies’ approach with regard to ratings between holding companies’ senior debt and operating companies’ senior debt in frameworks where potentially you have law with explicit subordination in insolvency; that’s a bit weird. Maybe rating agencies have been used to rating non-financials, where you have structural subordination from holding companies and things like that, but obviously big banks won’t go into insolvency so the process is a little bit different.

I very much agree with what they’re trying to do, which is build a framework around probability of default and loss given default, I give you that, but they still have to adjust the methodology for that.

I’m interested in seeing things like the double leverage that the holding company carries, so I can assess what the actual subordination is even if I’m a senior investor in a holding company but everything is being downstreamed in equity. This matters. Again

Vishal Savadia LLOYDS



14 Bank Capital

it goes into the probability of default versus loss-given default type of framework. Disclosure around that would be very welcome to help us solve this puzzle.

Krim, Morgan Stanley: So let’s assume that there was some downstreaming one-for-one, would you then look at holdco and opco debt as being the same risk?

Bian, BlackRock: Comparing opco debt from Germany, for example, if the draft law is passed and senior debt is explicitly subordinated to TLAC excluded liabilities, I think it’s fair enough to make this comparison. Obviously with legacy opco debt in the UK you’re talking about a different thing. But I guess explicit bail-inable senior debt in continental Europe versus holding company senior debt in UK is a fair comparison, absolutely, if the double leverage is not there.

Loriferne, Pimco: One of the reasons why there is this inconsistency and also why there is this relatively large spread between opco and holdco, especially in the UK, could be the confusion between the US and UK resolution regimes: the US framework has been well understood and well communicated for a few years now. TLAC came in late last year, and UK banks have only recently started to issue more from the holding companies in order to comply with the new requirements.

We need to understand that at least in Europe and the UK in particular the holdco cannot be forced to recap the opco beyond its original investment and it’s totally different than what we have in the US with the source of strength doctrine. So maybe it has made it harder to understand why in the UK the opco would be the first to take on the losses before passing on to the holding company depending on the level of losses incurred.

This is why the disclosure on how internal TLAC is being downstreamed from the holding company down to the opco is of paramount importance to us, in order have a good understanding of how losses will be spread across various parts of the capital structure.

: Germany and Spain have taken different routes to avoid this problem altogether. What do we think of Germany’s rather elegant solution of counting all senior debt towards TLAC?

Schotkamp, BBVA: The solution may be elegant, but the way it’s been done is not. Germany has a certain philosophy that allows them to take the approach they have taken. Can we think about a German solution being applied to Europe? If it is we think — and this is more the Spanish view — it needs to go through the revision of the BRRD and be done at a European level so the unilateral nature that Germany has chosen is curious.

BBVA and others have been able to survive from a liquidity point of view by having access to markets and not having to dig too deep into the usage of collateral. The statutory approach moves a financing instrument that’s been very useful at very important times into the capital stack. If this is what we want then that’s good, but make no mistake, your capital requirements will move you earlier on into a liquidity problem. Everybody at this table knows that banks die from liquidity problems and not from capital problems, and this is where the capital regulation overshoot is really worrisome.

Spain has defined an instrument that we could use

as a bank — it’s an option, we don’t have to — to create an extra stack of capital to potentially protect the usability of another instrument. I like that option.

Forrest, RBS: Erik has hit the nail on the head. For me with the German model, yes, you can see that as a solution. Taking a piece of legislation and saying, ‘this is going to have retrospective effect’, is a game-changer. If it’s something which has got a forward-looking basis — we’ve all sat round the table and talked about changes in terms of issuance of AT1, TLAC, etc — then it gives you time to plan for that.

As an investor, if you are holding a piece of paper which is senior today but then when a law passes it’s no longer senior, it is forming part of the capital structure, that is an instrument which prices at a different level and the ramifications of that are pretty significant.

Everwijn, Rabobank: I agree. It is the availability of senior unsecured funding you want to secure. That leads to the discussion we’re having with the rating agencies. First of all what’s the probability of default and secondly what is the loss-given default or failure? Our view is that we should have a buffer high enough to make sure that the probability of default is virtually zero and therefore immunise the operational liabilities you have outstanding.

If then for whatever reason the company makes losses greater than the capital you have on the balance sheet then you should use all the senior debt and all that is ranking pari passu with operational liabilities. Why differentiate? You sold an instrument that was senior in ranking to all the other instruments and you simply can’t change the rules during game.

Menounos, Morgan Stanley: I would like to explore the other side of the argument for a moment. Not all jurisdictions are represented in this discussion and not all regions are similar with respect to estimated gap to TLAC. There is an instinctive attractiveness in the ability to flick a switch and create a layer of bail-in capital from existing securities. After all, the adjustment phase, as well as the end point, could be pretty expensive if you consider the creation of a new class of securities that is structurally subordinated to outstanding securities.

Even if we end up with a structurally subordinated senior debt, my view is that there would still be a negotiation between issuers and investors around the right amount of capital, and this would depend on the bank, the business model and the jurisdiction. I fully agree that banks don’t ultimately fail because of capital holes, but it is the capital hole that leads to a run on

Scott Forrest ROYAL BANK OF SCOTLAND



Bank Capital 15

liquidity that ultimately brings a bank down.So we may get a combination of approaches, which is

unfortunately not going to help harmonisation and may eventually drive bigger differentials across Europe.

Krim, Morgan Stanley: We want to be able to say that whatever regime you use or route you choose, statutory or contractual or structural, it’s equal. On statutory harmonisation we need to give comfort to investors and issuers that going statutory works. Germany is going its own way but I think we need to see if there is a statutory solution in Europe, and explain how it works. We also need to think about the probability of default element. Will we really have a senior bail-in for any bank? It’s a tool that is nice to have and the fall-back solution. People are, however, focused on this bail-in tool and it is seen as being the only one that will be used by resolution authorities. There’s recovery planning, there are other resolution tools, and I don’t think any resolution authority would say my best option is to go for a senior bail-in. They want to have it because it’s the way to avoid a bailout but there will be other ways to resolve banks. Bail-in is new and triggers interest and focus but we should see it as a remote scenario.

Everwijn, Rabobank: I disagree with you there because we have sold certain paper to certain investors on the basis that it was senior unsecured. That is an agreement that we have made, even if the risk is limited. It’s the trust in the system. You can’t change the rules. If you don’t want to build up your capital ratios then there are alternatives, you have to create new instruments that can fill the gap, like the Spanish proposal. Then you have new issuance that is fulfilling that requirement if you want to optimise the cost of capital, but don’t try to touch senior unsecured.

Krim, Morgan Stanley: That’s what I’m saying, my point is bail-in of senior unsecured, even if it’s theoretically something that you can touch from a statutory standpoint, shouldn’t be the base case, it shouldn’t be what resolution authorities, issuers or even investors think would be the base case scenario in a resolution scenario.

Menounos, Morgan Stanley: But isn’t that the compromise then, in that harmonisation will have only been achieved on paper and in effect, banks may adopt different strategies?

Forrest, RBS: Another thing from an investor’s perspective. As a bank working on capital you’ve got a close, continuous and evolving relationship with the regulator. They’ve got much more visibility in terms of banks’ business requirements, capital requirements, business needs, stresses and strains as the business is run.

So in terms of the very end point, it’s bail-in and I totally agree with you, that’s the very end point there but there are a number of actions and levers that would come into effect before you even got to that end situation.

Bian, BlackRock: I think it adds a lot of cyclicality in business models. It’s great if you have a one weekend crisis and everything is very resolvable, but if you don’t get market access for a year or more, banks will have no other solution than shrinking the business. By shrinking the business it just adds to cyclicality. It could become a

self-fulfilling spiral if they breach buffers and there’s a lot of uncertainty and more money’s being withdrawn from the banks and banks have to shrink even more aggressively.

It’s fair to try to find a fine balance between what is your capital stack and what is your bail-in stack, but you also have to think about the unintended consequences from the actions you’re taking, or the risk that you’re overdoing in terms of regulation.

Schotkamp, BBVA: It is changing the rules of the game and I am hearing the same from other investors as well. It seems to be a concern for people. But I don’t see anything in the media, I hear no groups of investors saying what are we doing here? It seems all to be fine.

We do have the tier three in Spain and I kind of like it because thinking on a forward-looking basis, being conservative, management says ‘what is the cheapest option?’ How much did Deutsche Bank’s senior widen after the German law was announced? 10bps. Well, we’re going to go statutory because that’s cheap.

Markets in a way are telling us, ‘guys, go for statutory bail-in of senior unsecured because the spread pick-up or the spread widening you will see once that gets done is manageable’. This gets to the point, this is not going concern capital, this is if you’re dying you need to have something and that’s costly: an insurance policy for your funeral. We need to do this as cheaply as possible because that’s optimisation from a financial management point of view.

Loriferne, Pimco: Investors need to continue to be very selective. In our bond funds, we have broad guidelines in order to avoid being trapped in one particular tier in the capital structure in one particular country.

It’s important to understand that unexpected rule changes are very risky for everybody involved. If I look at the spreads of senior debt in Germany it’s widening much more than just 10bp, as the recent regulatory changes start to sink into investors’ minds. The senior spread has more than doubled for one bank in particular. So it clearly has direct implications in terms of cost of funding and it’s in the issuers’ hands to decide whether or not they want to reprice the entire senior stack of their capital structure.

We all understand senior is at risk. What matters is how those losses are passed on to the senior bondholders and this is where the No Creditor Worse Off is important. If you do change the law and make senior structurally subordinated then it begs the question, how will senior be treated, is senior becoming

Leopold Bian BLACKROCK



16 Bank Capital

subordinated? We know how subordinated debt tends to be treated close to or at resolution. So we’ll have to bear that in mind when we do price senior unsecured debt even though it’s a remote event.

If I look at continental Europe, we don’t have holdcos. However, there is enough debt outstanding that can be recycled over time with a new instrument. It doesn’t necessarily have to be tier three, it can be contractually bail-in-able senior, but it will be understood from day one by the investor community and hopefully priced accordingly. I understand Canada is thinking about doing that. If it’s possible there I don’t see why it’s not possible here.

: If we draw a line in the sand between what is tier three or senior bail-inable debt and what is pure senior funding, on the investor side would you be able to give credit to an issuer in terms of lower senior costs because they have a bail-in buffer?

Loriferne, Pimco: Yes, absolutely. Issuer communication around their capital strategy and how they think about their senior debt will have to be reflected in the price. So if a bank formulates a clear strategy to build up their capital buffers to protect their funding, it should be reflected in a potentially tighter spread.

But then you have also the counter example of a bank that has a lot of senior debt. If the entire stock of senior is fully bail-inable then the loss given default obviously is much lower as well.

The thing I don’t quite understand is, even though we still don’t have full clarity on what will count for TLAC, there are still banks that don’t want to issue or take the opportunity of current markets to build up capital buffers. At least meet the minimal requirements and then maybe go a little beyond what’s requested by Basel III just to try to be ready ahead of the TLAC implementation. I’m concerned that some banks will look at this too late and will then have to take more drastic actions that could be harmful for investors.

Schotkamp, BBVA: Are you thinking in particular about the Pillar 1 stack CRD IV capital?

Loriferne, Pimco: Yes. But that would be a good minimum, to meet the 1.5%-2% of RWAs to start with because you know you’re going to have to do that anyway. And then have a little more tier two, not necessarily a massive amount of tier two but you know tier two counts for everything, so it’s puzzling why you still see some issuers who are reluctant to issue just because apparently TLAC is unclear. I actually think the

direction of travel is pretty clear.

Schotkamp, BBVA: From our perspective if you want to frontload TLAC and work on it, it affects your liquidity planning as well because you’re talking about many hundreds of basis points in terms of money that you’re bringing on board. Then we need to think about in Spain are we running off Cedulas? For places in the world where the loan to deposit ratio is about 100 it’s even more, Mexico being an example.

Loriferne, Pimco: I agree, these are important considerations.

Schotkamp, BBVA: On Pillar 1 I’m with you but on TLAC, are we on a short horizon or phase-in, we don’t yet know. Do we proactively right now need to implement or translate the Spanish tier three option into our issuance programme? Maybe we should do.

Krim, Morgan Stanley: We’ve seen issuers doing that across Europe already. It’s happening, depending on the country and it is the right thing to in order to cater for future flexibility.

Loriferne, Pimco: Exactly, you have issuers who have already communicated their plans relatively clearly, and they will be rewarded over time for sure.

Savadia, Lloyds: It is interesting that you say rewarded over time and not now? You’ve got a clear direction of travel on MREL and TLAC pushing requirements higher. However, there is also a clear distinction between total capital ratios at present. The European average for total capital is around 15%, with several banks running total capital ratios significantly in excess of that. So why are we not yet seeing the immediate benefit on funding levels for those banks?

Loriferne, Pimco: Because similar to the holdco discussion, the market is slowly integrating the new risks associated to bail-in, TLAC and different resolution regimes. We have known for some time that bail-in was coming, but its actual implementation is creating different regimes across Europe as well as different issuing strategies among banks. As a result the investors also need to adjust their mindset when it comes to buying senior debt. And also you have the rating agency problem you mentioned before.

Bian, BlackRock: There is a very technical effect as well. Given the move in Bunds, a lot of the investor base got hurt pretty badly, especially the ones unhedged.

But again in the second half of last year senior massively outperformed; tier two and AT1s were being absolutely destroyed and senior wasn’t moving at all. So there’s a big degree of fluctuation. Rating agencies haven’t helped and the German proposal was the cherry on top of the cake just to completely disrupt the asset class.

Finding the right balance, whether senior should be 50bp, 100bp, 150bp over is like trying to discuss whether the Bund should be at 10bp or 80bp. It’s a hard science.

: Let’s move on to the actual market for bank capital. Alex, could you give us some observations from the sellside in the past 12 months?

Matthieu Loriferne PIMCO EUROPE



Bank Capital 17

Menounos, Morgan Stanley: The level of activity has picked up dramatically, with a lot of supply in the additional tier one format. We know roughly what the quantum of issuance needs to be and it is reassuring to see the overhang reduce and supply absorbed in the market. There has been considerable debate around structures, loss-absorption mechanisms and so on but we should now feel comfortable there is a mature and evolving market for the product. Tier two issuance on the other hand has been somewhat disappointing. This is probably down to uncertainty around TLAC, both with respect to quantum and qualifying instruments. For some, it makes little sense to issue expensive capital ahead of knowing the rules.

But technicals, as Leopold says, are indeed affecting the market. I do think that some issuers who are proactively executing on their plans, including perhaps some with potentially large gaps to TLAC, have already started feel the benefits. It is difficult to see this filter through to senior spreads due to broader demand/supply imbalances but it may become more apparent in tier two spreads.

: Vish, are we seeing people hold back on tier two because of TLAC?

Savadia, Lloyds: I don’t think you’re seeing people hold back. I think people are working through their capital planning in light of the developing regulatory framework. It’s interesting that we have seen a more limited supply of tier two instruments than expected, but markets have been volatile recently and banks are still finalising the objectives that they are working to.

Going back to your initial question about the market place in general, yes, we’ve taken massive strides over the last two years in AT1, particularly over the last 18 months and we are seeing the investor base for the asset class develop.

An outstanding issue for me is the lack of liquidity in that market place from dealers, which is increasing the volatility of this asset class regardless of the actual flow that we’re seeing. How as a dealer community do we actually see that improve over time? Because that is what is going to also hold back the further development of this market.

Krim, Morgan Stanley: There are some discussions happening on the regulatory side. I think this month and early July US regulators are getting banks, brokers and investors around the table to think about liquidity in the market and to try and put some proposals

forward to make sure that we have a secondary market that is liquid and functioning.

But again it’s one of the side-effects of the regulation that was implemented in the context of too big to fail, in particular definition and calibration of leverage ratio requirements.

Schotkamp, BBVA: That may be one reason banks are not printing the amount of capital you might expect. I’m not sure all shareholders completely understand the capital management framework, where if you don’t get tier two and tier one in time it’s going to be equity so you have to force your management teams to take advantage of this lower rate environment.

For many equity holders the only game in town is dividends. It is undoubtedly the case that Frankfurt focuses on dividend policy in connection with capital adequacy. The instrument on the table to manage that is the maximum distributable amounts (MDAs) and it goes back to shareholders and bondholders equally. I think there is a disconnect in this context.

Krim, Morgan Stanley: The shareholder view is ‘show me the evidence that running at a 20% or 22% total capital ratio is better than 17%, 18% or the bare minimum’, i.e., ‘what would be the savings and the spread differential for the cost of funding?’

Schotkamp, BBVA: How can you allow people to run around with enormous holes of AT1 to be filled in three, four, five years time, knowing that this may affect your dividend distribution policy? It’s very interesting.

: Could we have some experiences of the AT1 market from those that have used it recently, in terms of execution?

Everwijn, Rabobank: We are clearly one of the nations that were late in this cycle, mainly as a result of the tax deductibility discussion in the Netherlands.

The main difference in the review of the instrument compared to the first half of 2014 was the focus on the maximum distributable amounts and MDA buffers.

: Are we seeing the investor base widen from deal to deal?

Everwijn, Rabobank: If you look at what we did in 2011, at the time it was very close to new style tier one. The only investment base we saw was Asian private wealth with a bit of pick-up in Europe. Our deal in January was completely the reverse. The majority was institutional investors in London, across Europe and the US and a fairly small amount of private wealth, so there is certainly a huge difference in investor appetite.

: Has this become a less volatile secondary market this year, and a primary market less dependent on the broader market backdrop?

Bian, BlackRock: In our funds we do both financials and non-financials and in terms of market depth and liquidity, AT1 is much better than high yield. Liquidity’s there until you need it. I still think that there’s a lot of search for yield in the market, and when there is a crisis situation of any sort, AT1s are the first thing people kick out of funds.

Loriferne, Pimco: This market is becoming more mature,

Alex Menounos MORGAN STANLEY



18 Bank Capital

we see more institutional investors going into the AT1 market, which is good for everybody. One observation I would make is that over the past few weeks of market volatility, both in rates and in European peripheral debt, certain senior debt has actually slightly underperformed the AT1 market. Bond prices are down, don’t get me wrong, but it has held up relatively well which is encouraging and is maybe a sign that indeed we see a greater investor appetite and more mature investor base in this product.

Everwijn, Rabobank: The liquidity point worries us a lot. Liquidity is key in these transactions and performance is key in these transactions. Maybe we are in the same boat because we want these bonds to perform as well, and if they perform well it’s good for you as a return but it also enables us to look at the market for a future position and a potentially lower coupon.

As an issuer you are bound into what you can actually trade in these securities. Regulation makes it very tough to be active in the bond and we try to do whatever we can but yes, we rely especially very much on the dealers that should support these transactions.

Bian, BlackRock: In credit in general liquidity has been poor, it’s not AT1 market specific. With liquidity regulations and net stable funding ratios, LCRs and so on, the market in terms of trading has shrunk. So it’s not just a financials market problem, it’s the whole market but liquidity has dropped significantly and that’s going to stay with us. You’ve seen a couple of situations where you had a little bit of uncertainty and bonds dropped 20 points, on no trade, maybe 1m traded.

I still ask myself the question, you see these gaps with one issuer who seems to have an idiosyncratic problem. But when it’s a systemic problem, what’s going to happen? It’s down 20 points, will it drop 30 points, 40 points when nobody wants to hold it? That scares me a little bit and that’s one of the, again, unintended consequences of the whole change in regulations and everything that’s been done since the crisis.

: Looking ahead over the next 12 months, what are everyone’s key concerns? What might we be debating next year?

Schotkamp, BBVA: What we are busy with now is not whether the next tier one is going to come out with a new issuance premium of 25bp, or whether that needs to be euro or dollar trade, that is so secondary to the bigger picture stuff of TLAC and how we’re going to be tackling that. That is the big thing for us, thinking about how this is going to work.

Savadia, Lloyds: I think we’re entering a phase where we are hopefully getting towards the end of the broader debate around differing bank capital regulation. It is now putting the various frameworks into place and implementing them. This will be the task for all of us over the next few years.

Everwijn, Rabobank: For me it is asset encumbrance for the investor base. How much are you looking to asset encumbrance from a loss given-failure perspective? I think that is key, but then again we’ve been very vocal on asset encumbrance, which we want to be as low as possible. How much do investors value asset encumbrance?

Forrest, RBS: We’ve talked a lot today about bail-inable debt and how this might be implemented in the UK and other jurisdictions. There is still debate on whether some jurisdictions will choose statutory, contractual or structural subordination and clarity will be welcomed by the industry. Looking ahead I would like to see further development on how enforcement provisions in non-EEA jurisdictions would work in practice.

Loriferne, Pimco: What matters a lot at this stage of the regulatory cycle is to have a clear understanding of what bondholder rights and rules of engagement are. So what worries me is a potential significant impairment of bondholder rights. It is clear that senior is at risk of being bailed-in and can absorb losses just like with another non-financial corporation. When a corporate defaults, it goes to Chapter 11 or equivalent bankruptcy process where rules of engagement are relatively clear. But if regulations are aggressively changed there are significant risks to bank bondholder rights. That’s obviously a negative that will be reflected in the investment decision and ultimately in the spreads and investor appetite for the debt issued from this jurisdiction.

Bian, BlackRock: The direction we’re taking with regards to regulation is something that we have to get used to and this is just part of the investment process. Nothing’s risk-free. That’s all very well understood.

I do worry about regulators being more aggressive than they should, or would under normal conditions, be. And honestly, going back to the German proposal, that’s something that is borderline for me. You need to have well defined rules and property rights, so that’s one thing that I keep in the back of my mind with regard to uncertainty.

The other thing is liquidity. When you have a position, when you have a large portfolio of these securities, you want to be able to manage that portfolio in the most efficient way and when that’s not possible it becomes a very big headache for not just myself, but anyone in the market.

Menounos, Morgan Stanley: Potential developments around risk weights could be a big theme in the near future. We would all welcome harmonisation, but this should be a process that takes into account fundamental jurisdictional differences like local tax regimes and local foreclosure rules, and fundamentally different business models. In addition, this should not be a construct which incentivises the wrong type of behaviour, like low-risk banks incentivised to add risk in a binding floor scenario. The timing also worries me. Perhaps it would be better to delay the consultation until we have fully implemented the current set of regulatory guidelines, including MREL and TLAC, so that the impact of any changes to risk weights can be properly assessed.

Krim, Morgan Stanley: In a year’s time we will be sitting and thinking about what banks have got done in 2015 and 2016. We will see then how close we are to TLAC implementation, we would have seen the next round of stress tests from the SSM and we will have more experience of the ECB as the supervisor. We’ll always have market volatility and regulatory uncertainty. That will be on and off through cycles. We do, however, need to make sure we have a period of stability and certainty so that people can come forward and implement these new frameworks. s



PRIMARY MARKET UPDATE

IN BANK CAPITAL, 2014 turned out to be a hard act to follow. Banks printed more than €85bn of addi-tional tier one (AT1) and tier two last year, surpassing the total of 2013 and 2012 combined. But even though 2014 volumes actually fell short of estimates after a volatile fourth quarter put the brakes on pri-mary market activity, 2015 volumes have been struggling to keep up.

On January 1 Morgan Stanley was expecting to see some €65bn of AT1 and €45bn of tier two in the 12 months that lay ahead. As of June 30, both markets had barely reached a third of those tallies.

Banks have a lot of capital to raise, through instruments that offer the kind of return investors are begging for in the prevailing low yield envi-ronment, and the European Central Bank is backing up the entire credit market with €60bn a month in asset purchases. So what’s the hold up?

The answer to that question is a story of both internal and, increas-ingly, external obstacles for Europe-an banks.

AT1 fills outFor AT1 issuance, the obstacles are mostly internal.

“Net interest margin is a big focus point for most of our bank clients,” says Claus Skrumsager, co-head of global capital markets EMEA at Morgan Stanley.

“As an issuer when you issue a high yielding instrument in a rela-tively low yield environment you have to consider the NIM impact. There have also been some residual regulatory clarifications that needed to fall into place, especially around tax treatment.

“But I feel we are there now, I don’t think there are many other technical obstacles for issuers to point to for not being ready to pull the trigger.”

This is borne out by a substan-tial broadening of the AT1 issuer

base in the first half of 2015, some-thing investors have been waiting months for.

Ireland and the Netherlands, for example, two jurisdictions where uncertainty over the tax treatment of AT1 coupons has long held back issuance, have both seen issu-ers launch inaugural transactions in the last six months. The long-awaited appearance of Scandina-vian issuers also helped first quar-ter supply to €11.5bn equivalent, though just €4.5bn of that total came in euros.

Even Standard Chartered and BNP Paribas, banks with two of the long-est AT1 ‘to do’ lists, finally got in on the act with trades in March and June, respectively.

“We have a good sense of what the total quantum of additional tier one supply will be,” says Alex Menou-nos, co-head of EMEA FIG DCM and head of EMEA debt syndicate at Morgan Stanley.

“Over the last 12 months some [banks] have migrated from a target of 1.5% of RWAs to 2% or above, as issuers solve for binding constraints, like leverage ratio targets. Some may also consider building buffers to proactively manage potential near term headwinds to capital.”

Hungry buyersBanks coming to the market for the first time have been met by a broader and deeper investor base than ever before. The more issuers and transactions there are, the more attractive the product becomes as investors can use more data points to assess relative value.

That new support was neatly dem-onstrated when UBS made its debut in February, taking away €3.5bn equivalent in one transaction by peppering the curve with different call dates across three tranches in euros and dollars.

Bankers feel AT1 is close to reach-ing critical mass on the buy side,

with buy and hold investors tak-ing the asset class more seriously adding to a dedicated club of loss absorbing instrument buyers, who are comfortable with the related plethora of risks they present.

“Eighteen months ago we had a big focus on trigger levels and buff-ers to triggers,” says Menounos.

“Gradually over the last 12 months focus has shifted to coupon risk, initially with MDAs, then ADIs and now with Pillar 2 impact on com-bined buffers. There will come a point in the future when extension risk gains relevance, likely as we approach the first call dates of CRD IV generation AT1 transactions.”

From an investor point of view one of the biggest concerns around the asset class is now liquidity. No market has escaped the liquidity drought of 2015, but AT1 investors feel that whenever the first non-payment of an AT1 coupon arrives, the market will be tested like never before.

However, most market partici-pants are positive on the outlook for tier one supply in the second half of 2015, and beyond.

“We are at a tipping point,” says Skrumsager. “If the market con-tinues to be as constructive as it is — subject to Greece — issuers will come to market, and if you look on a 12 or 18 month basis, they will make up for the limited issuance in the first half of 2015.”

Tier two is where the external

Just as Europe’s banks were really getting stuck in to their post-crisis regulatory capital requirements, rulemakers have thrown them another curveball that will define issuance patterns for the rest of the decade, writes Tom Porter.

Banks await final orders with markets open for business

“We have a good sense of what the total quantum of

additional tier one supply will be”

Alex Menounos, Morgan Stanley

019-20 Market Update.indd 19 06/07/2015 09:04


PRIMARY MARKET UPDATE

obstacles come into play. Or rather one big obsta-cle, the elephant sat in the corner of most bank treasury meetings — the Financial Stability Board’s total loss absorbing capacity rules, or TLAC.

“Tier two supply in the first half of the year has been below what we might have expect-ed,” says Andrew Fraser, investment director for credit at Standard Life.

“Banks are holding off until they see the final TLAC numbers. I don’t think we are going to see the TLAC requirements being watered down that much, so we should start to see more tier two supply in the second half of the year as a way of catch-ing up to what banks need as a total capital stack, rather than a focus on tier one.”

Supply in the product has been held up in the second quarter by other unforeseen factors, first vola-tility in underlying European rates and then Greece’s never ending bat-tle with its creditors.

In the last full week of June ABN Amro and HSBC offered around 40bp or more of new issue premium for a pair of €1.5bn tier two prints, highlighting a desire among banks to keep up with their issuance plans at no small cost.

However, getting the deals done in a week when conflicting news on Greece’s future in the eurozone was emerging every hour did hint at another positive for borrowers — investors are now much less skittish about the health of the European banking system than they were 12 months ago and as long as the price is right they are willing to pick up the risk at virtually any time.

No certaintyThe world’s 29 largest banks will learn in November what num-ber between 16% and 20% of risk weighted assets they will need to hold as loss absorbing debt. But the amount of extra debt required — estimates have reduced since the initial €500bn-€1tr numbers of late 2014 — is no longer the biggest problem.

It is rather the way TLAC will

be implemented, particularly in Europe, which is going to funda-mentally alter how banks go about building their capital bases in the run up to 2019.

Germany at present intends to make all senior unsecured debt eli-gible for TLAC, while Spain has taken the different approach of allowing banks to issue a new layer of contractually bail-inable debt loosely defined as ‘tier three’. Coun-tries like France and the Nether-lands are yet to indicate their own plans.

“We are not likely to see a sub-stantial wave of tier two issuance to fill TLAC requirements, at least not to the extent feared late last year,” says Menounos.

“Indeed, we may well see a com-bination of different approaches across Europe, even if a ‘German proposal’ prevails, including poten-tially the development of a new class of structurally or statutorily subordinated securities.”

Throw a stick in Europe and you will probably hit a bank treasurer that is none too happy with the Ger-man proposal, as long as you don’t throw it near Deutsche Bank. Many say it amounts to changing the rules of the game at half-time.

Investors aren’t too happy about the latest developments either. They add further layers of national idi-osyncrasy to a European market already overburdened with them.

In the mixFor issuers the next 12 months are going to be dominated by one goal — complying with whatever nation-al framework they end up with as

cheaply as possible.“The question now is

not the amount of debt you need to issue for TLAC or MREL purpos-es, the question is what the potential widening of your senior curve is if you don’t have capital protecting it,” says Khalid Krim, head of capital solutions EMEA at Mor-gan Stanley.

“We have moved from expecting banks to fill TLAC with tier two or tier three to a point where our conversations are around

what is the right mix in terms of capital structure and what is the size of the buffer required to have sen-ior debt counting for TLAC without widening senior spreads too much.

“What banks don’t want to see is them underperforming on spreads because their peers have a bigger buffer, higher rating or a better com-munication to the market on their TLAC/MREL strategy.”

To quote one European bank treasurer, institutions have accept-ed the reality of senior spreads wid-ening. What they can’t abide is the market differential being 40bp-50bp and their name being the only one at 70bp-80bp.

TLAC and MREL should be the final pieces of the puzzle for post-crisis bank capital structures.

Only when banks know the ulti-mate quantum of capital they need to raise can they finally put together a plan to get there in the most effi-cient way for them by 2019.

Analysts initially predicted TLAC would add up to €1tr to banks’ requirements, causing a brief panic among European DCM teams that they would have to find a home for all the new bonds. But there was similar consternation in the early days of the AT1 market, and banks could soon be reaching the half way point of that issuance burden.

“The structure around AT1 is very settled, but you need to remem-ber it took us two to three years to get there,” says Skrumsager. “The TLAC/MREL debate is just settling now, so there will likely be a two to three year delay before we see fully the issuance impact as a conse-quence of that regulation.” s

0

250

500

750

1,000

2012 2013 2014 2015

Tier 2 Tier 1

Bank capital spreads (bp) 2012-2015


019-20 Market Update.indd 20 06/07/2015 09:05


AT1 MAP

European AT1 landscape: overview of structures

Trigger level● 8%● 5.125% (issuers sub-conso)

Loss absorption ● Conversion: Swedbank

● Temporary Write-Down: Handelsbanken, Nordea, SEB

Trigger level ● 7% (standard)

Loss absorption ● Conversion: Barclays, HSBC, Lloyds , Nationwide, Standard Chartered

● Permanent Write-Down: Santander UK

Trigger level● 5.125% (standard)● 7% (Permanent TSB)

Loss absorption ● Conversion: Permanent TSB

● Temporary Write-Down: Bank of Ireland

Trigger level● 7%● 5.125% (Rabobank sub-conso)

Loss absorption ● Temporary Write-Down: Rabobank

● Conversion: ING

Trigger level ● 5.125% (standard)

Loss absorption ● Temporary Write-Down: KBC

Trigger level● 5.125% (standard)● 7% (Groupe Crédit Agricole)

Loss absorption ● Temporary Write-Down: BNP Paribas, Crédit Agricole SA, Société Générale

Trigger level● 5.125% (standard)● 7% (Banco Popular)

Loss absorption ● Conversion: BBVA, Santander, Banco Popular

Trigger level ● 5.125% (standard)

Loss absorption ● Temporary Write-Down: UniCredit

Trigger level● 5.125% (standard)● 7% (Aareal)

Loss absorption ● Temporary Write-Down: Deutsche Bank, Aareal

Trigger level● 5.125%● 7% (Danske)● 7.125% (Nykredit)

Loss absorption ● Temporary Write-Down: DNB, Dan-ske, Nykredit

€23.6bn

€0.7bn

€69.3bn

€4.7bn

€0.9bn

€9.5bn

€8.9bn

€1.9bn

€5.0bn

€3.6bn

€2.0bn

€1.4bn


= Total AT1 issuance to date

021 AT1 Map.indd 21 06/07/2015 09:06

22 | July 2015 | Bank Capital: The Final Countdown

INSURANCE CAPITAL INSURANCE CAPITAL

THE REGULATION has been a long time coming, even by the standards of the often sluggish European legis-lative mechanism. When the direc-tive finally comes into force next year, it will already be 10 years old, having been delayed several times. Finally, however, it seems insurers have a new framework on the horizon.

“Solvency II is at the top of the mind for investors, which wasn’t as much the case last year,” says Matteo Castelvetri, managing director in the financial institutions group, EMEA, at Morgan Stanley in London. “It goes live on January 1, 2016 hence there has been a lot of focus from issuers on disclosure — they’re trying to address investors’ questions and concerns.”

Even with the implementation date rapidly approaching, there’s still uncertainty on exactly how the final implementation of Solvency II will look. National regulators still need to work out exactly how they will trans-pose the Solvency II directive to their domestic systems.

That’s a problem for investors, who naturally want a high level of under-standing of what they’re buying.

While insurers have already begun releasing preliminary figures for how high their solvency ratios will be under the new regime, the lack of clarity on what the final figures will look like — and the difficulty of comparing these preliminary figures between institutions using different models — mean it’s a confusing time to be an insurance investor.

“The biggest challenge of the new system is communication with investors,” says Duncan Russell, head of corporate finance and group strategy at NN Group. “It’s a compli-cated topic and we have to help investors to understand what’s differ-ent and how to interpret and compare the numbers.”

But it’s also a difficult situation for the issuers in the sector which still

need to receive the final sign-off from their regulators for how they model their internal risk ratios — particu-larly tricky for multinationals dealing with multiple regulators.

Volumes to stay stableOne thing’s for sure, insurers are going to need to issue plenty of the new Solvency II compliant instru-ments to meet their obligations — even if that just involves refinancing their maturing legacy Solvency I instruments.

Data from Morgan Stanley shows that insurers are going to need to issue at least €10bn of capital a year for the next five years — 2018 exclud-ed, where the figure is slightly lower at €9.7bn — peaking in 2017, where the bank predicts a refinancing need of €14.7bn.

The figures may look small com-pared to the amount of AT1 and tier two capital that their counterparts in the banking sector need to issue, but insurers have always been more infre-

quent in the capital markets.Indeed, volumes are unlikely to

climb much beyond those refinancing needs, making life easier for company treasurers as they enjoy a distinct rarity factor compared to other finan-cial institutions.

“Issuance is likely to be broadly sta-ble and based on redemptions,” says Maxime Stevignon, head of European insurance coverage at Morgan Stanley in London. “Though factors like M&A, increasing capital supply, and delever-aging, reducing senior funding, could also have an impact. That’s a key dif-ferentiator from the bank market, where we expect volumes to increase significantly. Insurance paper will stay rare compared to bank debt — the sector is structurally well support-ed and attractive to investors.”

Tier two evolution, tier one revolutionThe first wave of Solvency II com-pliant tier two trades has begun to arrive. Issuers like Aviva have tapped

The banking sector has already gone through much of the confusion of its own regulatory overhaul, with once exotic instruments like additional tier one becoming practically mainstream. With Solvency II on the horizon, it’s now the insurance sector’s turn, writes Nathan Collins.

Insurers finally come face to face with Solvency II

1.3 2.6

4.2

1.7 3.8

4.2 2.0

1.7

4.4

3.7

7.4 8.2

8.4

2.9 1.9

0.3

0.8 0.8

12.8 12.7

14.7

9.7 10.1

0.0

5.0

10.0

15.0

20.0

2015 2016 2017 2018 2019

LT2 UT2 T1 CoCo $bn

Insurance capital refinancing needs by year (€bn)Source: Morgan Stanley

Insurance capital refinancing needs by year


022-23 Capital Insurance .indd 22 06/07/2015 09:05

Bank Capital: The Final Countdown | July 2015 | 23

INSURANCE CAPITAL INSURANCE CAPITAL

the market this year and bankers say there is a hefty pipeline of similar trades expected to take place later in the year.

The deals have had a favourable reception from investors — helpful-ly Solvency II tier twos are actually pretty similar to the Solvency I instru-ments. CreditSights analysts predict that the standard Solvency II com-pliant tier two will be a 30 year non-call 10 note, which certainly does not reinvent the wheel from what insurers were selling under the old framework.

They do, however, differ sharply from their Basel III cousins. The Sol-vency II regime permits tier twos to be structured with dividend stop-pers and step-up clauses, both disal-lowed under Basel III. Solvency tier twos also have a minimum tenor of 10 years, compared to Basel’s five years.

“On the more recent Solvency II compliant tier twos we haven’t seen significant divergence from Solvency I instruments in terms of price,” says Stevignon. “Issuers and investors are very comfortable with Solvency II tier twos, the structures are very well understood. The main developments are on the tier one side.”

Indeed, while the tier two market is already off to a good start, most bank-ers expect it’ll be a little while before we see our first Solvency II compliant tier one print. Issuers are expected to wait until they publish their fourth quarter 2015 results — giving inves-tors a full insight into their position under the new regulation — mean-ing the first Solvency II compliant tier one is unlikely to hit screens before the first quarter of 2016.

The delay is exacerbated by a sense of first-mover disadvantage: insur-ance funding teams are likely to want one of their peers to take the plunge first, giving them an opportunity to learn by example.

“As maturities of tier one debt come due issuers are going to be asking whether they should refinance that with more tier one or with cheaper and more familiar tier two instru-ments,” says Castelvetri. “There is a bit of a game of who blinks first — insurers are waiting for the first issuer to bring a Solvency II tier one, from there we’ll probably see an ava-lanche effect.”

Of course, there is also the chance that some issuers will largely shun the tier one market, judging that the cost

and unreliability of the instruments make other sources of capital preferable.

“For banks it’s clear that AT1 is essential, that’s less obvious for insurers,” adds Castelvetri. “While CET1 ratios for banks are RWA-driv-en, for insurers it’s a percentage of your total tier one, including equity. That means as your equity shrinks, so does your tier one. That means AT1 is less attractive for insurers: you pay to issue the capital and then, when you need it, it may be less than what you expected.”

Additionally, with so much uncer-tainty still persisting on how exact-ly national regulators will be imple-menting Solvency II, insurers have plenty of reasons to hold off bringing the first of the new instruments — if they need to issue any at all.

“We have to have our discussions with the regulator on how these secu-rities will be treated,” says Russell. “There’s still uncertainty and once we know exactly how the new regime looks we can weigh up our options. We’ll be pragmatic and see what’s more appropriate at the time.”

Basel sets an exampleWhile insurers may need time before they’re ready to start issuing tier ones, one factor in their favour is that inves-tors have had plenty of opportunities to become familiar with the banking sector equivalent: Basel III compliant additional tier ones.

While Solvency II may be different in many ways, at least investors have had a chance to get savvy with capital ratios and analysing the importance of regulatory triggers.

The structures of Solvency II AT1s will be very similar to Basel III AT1s. Among other things, they occupy the same part of the capital structure, have the same minimum call periods and both have discretionary and non-cumulative coupon payments.

Both also convert into equity or write down on trigger events, with the difference being that a bank AT1 is triggered at a set core equity tier one ratio while the Solvency II instru-ments trigger if the issuer’s Solvency Ratio — a ratio based on the mark-to-market value of its assets — falls below a certain level.

“Investors can use their experience dealing with bank AT1s when looking at the Solvency II compliant

deals when they come,” says Stevi-gnon. “Investor education isn’t going to be a constraint on the develop-ment of the market. Looking at bank AT1s they’ve learned how to do the bespoke analysis on buffer-to- triggers and other risks.”

The usual suspectsUnsurprisingly, the most likely candi-dates for the first Solvency II tier one are the cream of the insurance crop, with the largest and most sophisticat-ed insurers the most obvious candidates to lead the way for their smaller brethren.

Those issuers have been publish-ing preliminary ratios for the longest time, meaning investors have had far more of an opportunity to wrap their heads around how they shape up under the new regulatory regime.

“Those issuers who are able to dem-onstrate resilience in their solven-cy ratio are going to be favoured by investors,” says Stevignon. “At first, that’s going to be the European lead-ers who have been publishing prelim-inary ratios and can show how those ratios have evolved. It’s going to take time before the less sophisticated issuers can show that.”

Allianz has been named as an obvi-ous first issuer, but it is by no means the only possibility.

Even once Solvency II deals begin to hit the screens with regularity, there’s still plenty of work to be done. The banking sector was well ahead of insurance in setting up the first part of its new regulatory regime and the insurance sector has barely even begun to think about the next stage of innovating the industry: how to deal with failing and failed institutions.

“On the bank side we’ve seen the resolution framework being debated and implemented,” says Stevignon. “On the insurance side that debate is only just beginning.” s

“There is a bit of a game of who blinks

first — insurers are waiting for the first

issuer to bring a Solvency II tier one,

from there we’ll probably see an

avalanche effect.”

Matteo Castelvetri, Morgan Stanley

022-23 Capital Insurance .indd 23 06/07/2015 09:05

24 Bank Capital

Bank Capital Investors’ Roundtable

: Let’s start with the tier one capital mar-ket. We had over €40bn of additional tier one issuance last year. We’ve had over €20bn-equivalent issued so far this year and expectations are for a total €50bn in 2015. A Morgan Stanley survey of 192 investors in April suggested asset managers hold 72% of the AT1 market, and 93% of those polled said they could buy AT1. How much more development does this asset class have left to do?

Toby Dodson, Achievement Asset Management: From our perspective, having been involved in the asset class going back all the way to BBVA’s first deal, we’ve defi-nitely seen a change in behaviour in the last 12 months. If you look at how deals have performed in secondary during recent periods of market stress, there have defi-nitely been days this year where if the asset class had been in the same place it was 12 to 18 months ago, we would have seen two to three point gap moves in AT1, and we’re not seeing that.

The asset class has definitely matured, it’s behav-

ing a lot better on the secondary side and that prob-ably speaks to a deeper and more diverse investor base, and maybe an investor base that is educated about the product and understands the nuances of what they own better, rather than someone who is jumping into it for a short term trade. I struggle to believe that 93% of inves-tors can buy AT1, but we’ve been pleasantly surprised about the way the securities have traded in terms of prices.

On the flip side, I would say liquidity is just as chal-lenging today in some regards as it was 12-18 months ago. The ability to transact in any meaningful size on the secondary side has in some ways diminished, so you have to be very comfortable with what is in your portfolio. I think we all expect the day will come when the asset class faces its first real fundamental rather than market test, and how the asset class trades on that day will be most telling.

Georgina Aspden, Goldman Sachs Asset Management: The market is still evolving. We’re not there yet. When

Participants in the roundtable were:

Georgina Aspden, European banks senior analyst, Goldman Sachs Asset Management

Leopold Bian, bank analyst, BlackRock

David Butler, head of financials credit research, Rogge Global Partners

Toby Dodson, Achievement Asset Management

Bruno Duarte, financials analyst, Claren Road Asset Management

Rogier Everwijn, head of capital and secured products, Rabobank

Khalid Krim, head of capital solutions, EMEA, Morgan Stanley

Dan Lustig, senior credit analyst, Legal & General Investment Management

Alex Menounos, head of EMEA syndicate and co-head of EMEA FIG DCM, Morgan Stanley

Erik Schotkamp, head of capital management and long term funding, BBVA

Tom Porter, moderator, GlobalCapital

Investors confront shifting sands of bank capital risks

As regulators have looked to make banks bankruptcy-proof in the years since the financial crisis, bank capital investors have been forced to adapt quickly to new layers of protection. For seasoned buyers, the disruptive force of the Financial Stability Board’s rules on total loss-absorbing capacity (TLAC) is simply the next challenge.

A couple of years ago many found the risks attached to additional tier one capital uncomfortable, but now, there is a broadening acceptance that nothing is risk-free, and buyers are forced to make judgments on a case-by-case basis.GlobalCapital gathered six leading investors, two top issuers and two investment bankers to tussle with the knots

of complexity in a market where the final shape is still to be decided.

024-33 Investors Roundtable.indd 24 06/07/2015 09:09


Bank Capital 25

you look at supply estimates there’s a lot more still to come, and even policies aren’t completely finalised on how regulators want banks to change the composition of their capital structures. So there is still room for more variation. With every new deal that comes out there’s always a slight change or nuance from one to the other. You could only say something is fully evolved when it becomes fully standardised, when there’s no variation.

Dan Lustig, Legal & General Investment Manage-ment: I tend to agree. The market is well developed, with around €70bn of issuance so far, but it’s not yet fully developed. What you actually need for a market to become fully developed is a clearer and more certain regulatory environment.

Investors need more clarity on evolving regulations that have risks and pricing implications. For exam-ple, what are the total loss-absorbing capacity [TLAC] requirements? What are the Pillar 2 requirements? Are they going to be included in the minimum capital requirements for AT1 coupon payment?

Liquidity is also a very important requirement. We need better liquidity and a more permanent investor base, and I think that this market has benefited from the European Central Bank’s quantitative easing programme as well, which has driven a search for yield.

The first test will be once interest rates start to rise, or perhaps when the first issuer needs to refinance an AT1 deal. That would be a milestone. Once we’re there, the market will mature and will be fully developed.

Alex Menounos, Morgan Stanley: This highlights a very good point. Two years ago, if we had polled a similar audience on ranking the three risks that differentiate AT1 from senior debt, namely principal risk, coupon risk and extension risk, number one on the list would have been the risk to principal. About a year to 18 months ago, this started to shift gradually towards coupon risk.

The focus today is probably still on coupon risk, although maybe for different reasons. Initially it was minimum distributable amount [MDA], then it became available distributable items [ADI] risk, and now inves-tors are focused on Pillar 2 and potential impact on combined buffers. Extension risk still seems to be lower down the list. Have views changed, or do investors still think that’s the right order?

David Butler, Rogge Global Partners: The market is definitely focused at this point on coupon defer-ral risk. You’re right, when this first started we were more focused on the triggers and then people started to become more comfortable with that. Also, the trigger

levels in absolute terms have improved versus where capital levels have been moving.

Coupon risk is still going to be the key issue for the foreseeable future, because the actual buffer rules around that are still evolving. To a certain extent inves-tors are still buying a little bit on trust in terms of where that coupon deferral point could actually be, and obvi-ously disclosure varies as well.

Sometimes it’s the bank’s disclosure, sometimes the information just isn’t there at this point. My sense is that extension risk is probably out there somewhere, but it’s not what people are focusing on in their analysis.

Bruno Duarte, Claren Road Asset Management: Espe-cially when you consider the first deal that came, 810bp over, that was your spread, right Erik? I would like to think you would not be extending that and you can refi-nance that much cheaper.

We have to bear in mind that the early deals did have a much higher reset rate, but rates have subsequently come in, as Dan alluded to. We were surprised recent-ly because we communicated with some real money accounts on the continent and in countries where we thought they could not buy AT1. They’re talking about having substantial inflows into funds for AT1 and sup-porting bank capital products.

So, whether it’s because the ‘risk-free’ Bunds are get-ting too low [in yield], whether it’s the effect of QE, the asset class has clearly stabilised. To Toby’s point, the AT1 market today has evolved versus what it was one and a half to two years ago. Georgina’s right, it still has to go a little bit further, but we have been pleasantly amazed at how well behaved it has been throughout this whole Greece episode and other unknown factors.

You’re definitely seeing a much different market reac-tion to spread products, like senior secured and tier two, compared to AT1. Historically you would have thought it’s got to have a multiple effect in terms of the move-ment, but it’s just not there.

That, we think, is a good sign for the asset class. It also shows you that the actual investor base is becom-ing much more knowledgeable about what they have in their portfolios. That’s partly also down to the banks getting stronger, the education process getting better and we just have to wait for the first new deal to refinance. We need to see they can be refinanced without regula-tory objections, so that it’s not something we have to worry about.

Leopold Bian, BlackRock: Given that the first call date for an AT1 security is 2018, I think markets focus on things at the time. The 2018 step-ups are relatively expensive, given today’s markets. Coupon risk obviously is still in people’s minds, but beyond MDA risk and ADI and so on, there’s also another big factor, which is regu-latory discretion.

That’s a huge power that hasn’t been tested. You make a huge loss, you’re still above your buffers, but who knows, maybe the regulator thinks it’s prudent to switch off coupons. The more uncertainty you have, the more you’re preoccupied with these issues.

On the point of liquidity, it’s got much better. It’s very helpful to have funds dedicated to these products because then it’s actually the benchmark. You used to see behaviour from a lot of asset managers that had their benchmarks and then had a little buffer to invest in non-benchmark instruments, and AT1 was very appealing.

It’s good when it’s going up because it’s additional alpha you generate versus your benchmark, but then when things go down it’s the other way round and it’s

Alex Menounos MORGAN STANLEY



26 Bank Capital

the first thing they want to sell. So, the less you have of these types of mandates and the more you have dedicat-ed funds aligned with the product, the better the market will be.

Rogier Everwijn, Rabobank: In terms of valuation, do you refer to spreads? Is this now already getting to be a market where the various transactions are compared on a spread basis or is it still on a coupon or yield basis?

Our experience in the 2010 and 2011 transactions was still on a coupon basis. I know you can’t compare the investor bases, especially for our 2011 transactions, which were predominantly sold into private wealth in Asia, which is really coupon-focused. But is this now an instrument that is getting mature enough to compare it on a spread basis, even if the coupon is still relatively important?

Butler, Rogge: That’s another way in which the market has maybe moved on. Certainly, it was obvious that a lot of the buying with fairly early vintage AT1s was outright yield-driven. You can see that in the fact that curves were not only flat but often inverted on that basis, and it hasn’t actually adjusted quite as much as it should do.

That’s still going to play out over time. People will start thinking about spreads and that would be consist-ent with the idea that is implied here, which is that we’re moving from an outright yield, private bank, pri-vate wealth buyer base to an institutional investor base that is thinking about relative value in that kind of way.

: Is the job of a financials credit analyst easier or harder now than it was pre-crisis? I know one head of capital solutions, not you Khalid, who takes the view that it has become easier for investors because the regulators are doing a lot of the work for you. Would you agree?

Bian, BlackRock: It’s pretty hard from the uncertain-ty you have with the regulator. The regulator has an immense amount of power today, which is very much behind closed doors. All these processes, we were discussing about Pillar 2, these things are completely unknown to the market. The processes, the conversa-tions the regulator has with the banks, it’s very hard to estimate that, it’s very hard to calculate that. The job of financials analysts is to assess the riskiness of the credit. With the regulatory discretion it’s tough, because it adds a huge amount of uncertainty that can’t actually be measured, and to some extent the banks can’t talk about. And obviously we don’t have access to the Single Supervisory Mechanism (SSM).

Dodson, Achievement: I would say that the regulator has been good enough to keep financial analysts in a job, because though they’ve undoubtedly lowered the probability of default for banks, certainly the actions they’ve taken and the rules they’ve put in place have probably been some of the most market-moving events, specific to the financial sector rather than macro, over the last couple of years.

So I would definitely disagree with whichever head of capital solutions said that to you. I’m very grateful to the regulators for keeping me busy.

Menounos, Morgan Stanley: But does that make the investor community focus more on jurisdiction, or per-haps create a bias for national champions?

Dodson, Achievement: It means you have to have,

despite Europe’s best efforts to harmonise, an under-standing of the laws and regulations of each individu-al jurisdiction. That has in many ways multiplied the amount of work you have to do, because whatever you’re doing for each individual nation or nationality, you have to do yet again if you’re looking at a French bank or a German bank or a Spanish bank. Only a few weeks ago the Germans proposed a piece of legislation that totally changes the hierarchy of creditor claims in their country, which is yet to be applicable anywhere else in Europe.

: Erik, you were an early mover in the mar-ket, you’ve done a few trades and a number of road-shows. Can you tell us a little bit about your experience in terms of the investor base? Are the questions you get from investors changing?

Erik Schotkamp, BBVA: This came about through CRD IV, which identified the possibility of issuing an instru-ment that hadn’t been tested and had a lot of bells and whistles, of which everyone was very sceptical. That was definitely a very interesting experience, because we talked to the 10 leading investment firms in London before deciding to go out, and that’s where you learn and understand.

There was a focus on trigger. Nobody thought about MDAs. But we see the same people coming back. I still see it as a pocket in the market, which, without the fundamental support of those people that we met back then, is not going to function. That leadership is neces-sary. Whether it’s from the big platforms or the lever-aged money or the dedicated specialist funds, it’s still for me the same go-to people if I want to do a bit of brain-picking to see how they feel about the market.

But it definitely has become broader, you can tell by the tickets. The last breakfast we did in France we had 30 accounts. The first two trades we didn’t. So it’s broadening out, yes, but I don’t think it is ready to stand on its own two feet yet.

You can tell by the number of names. If you do a sub-ordinated trade, which is the closest thing to an AT1, you get a book of 400 names and you can do without many of them. In AT1 you can’t do without them. It remains a club of specialised investors.

:How about the regulatory process? Has that become more streamlined with familiarity?

Schotkamp, BBVA: Our first AT1 prospectus took us 3-1/2 months to get approved, because of the amount of reviews with the regulator. The second one, because

Toby Dodson ACHIEVEMENT ASSET MANAGEMENT



Bank Capital 27

it was copy-based, they were more comfortable and we got a bit of recognition. The last one we did approval with the ECB. We showed them an edited version and indicated where we had changed it versus the last pro-spectus. That’s what they reviewed and they said ‘go ahead and execute’.

They want to move to rapid approval processes, which means you are going to have your call for stand-ardisation. The regulator has moved from sceptical on whether this product would work to being pretty com-fortable and actually seeing it as market development. They see it as a true pocket of loss-absorbing capital.

Which means that as long as your combined buffer requirements are subject to phase-in, the MDA is subject to phase-in, the hard debate about switching off coupons will be applicable to banks that are in really bad shape, probably without frivolous, rule-based switch-offs.

I’m thinking there is an intermediate stage, which is a recovery plan, and the materiality of switching off a coupon for capital recovery is probably not big enough, vis-a-vis the loss of access to markets to what is a true loss-absorbing instrument.

Krim, Morgan Stanley: I would echo that. If you look at the reports the EBA have done on tier one, looking at the structure across Europe, there is an effort to harmo-nise. Investors understand the differences across jurisdic-tions, the reasons behind issuers’ choices of high trigger, low trigger, permanent or temporary write-down, con-version and so on.

To increase harmonisation further, the EBA said recently in a public hearing that they would be working on standardised term sheets they can give to all issuers, which can be used by banks that haven’t issued already as a basis for AT1 and other instruments.

But we do have a new supervisor that will be look-ing at the value of AT1. It’s there and it can absorb shocks, but I think the way supervisors are looking at it is, increased supervision and more focus on the SREP [Supervisory Review and Evaluation Process], the Pillar 2, and ex-ante actions and supervision of the banks, to make sure that there is no accident, as opposed to wait-ing for the accident to happen and then acting post-trig-ger of AT1 or other securities.

The next stress test is happening early next year. This will be key to understanding how the ECB is work-ing with all the banks. I view the move in Europe to an annual stress testing of banks, like the US and UK, as a healthy and positive development.

Aspden, GSAM: The other thing still in evolution is dis-closure. There is a lot of focus on coupon deferral and

not all banks disclose enough information to be able to accurately assess that risk.

And on top of that, the ECB, as you say, is now more focused on its own capital adequacy requirements and some countries have disclosed those, other countries haven’t. That doesn’t create a very even playing field. It keeps us in a job, because then we have to make our estimates around it, but that would obviously be another point for evolution that still hasn’t come.

Schotkamp, BBVA: In that sense your demands are com-pletely legitimate, but you cannot underestimate that the list of priorities these regulators are looking at, it just comes at the bottom half. I’m not saying that’s good news, but we have had debates with the joint superviso-ry team and we come up with questions and they look at you as if to say, ‘that is a good question, we need to think about it’.

Two weeks later, you have a follow-up call and they say, ‘we talked about it and we think it’s relevant, but we have never before thought about it’. I’m not sure if that’s human nature, if it’s understaffing, it’s priorities, it’s a lack of technical skills, but there’s a lot of that stuff about MDAs. I’m not aware there’s any European regu-lator that really has a great feel about the MDAs of its leading national banks.

Available distributable items — it’s almost like, can you distribute share reserves? Maybe theoretically you can. Are we going to do it? I’m not sure. So, a reality check on what you can count on once you get there, versus what the book says, is definitely needed.

Are capital ratios of banks being audited? They’re not. That’s interesting, given that we’ve got triggers, we pub-licise numbers, but the composition of your capital and the core capital ratio are not audited.

Menounos, Morgan Stanley: Yet you have economic risk driven off those numbers. Looks like financials analysts will be busy for a while.

Schotkamp, BBVA: That’s right, market inefficiency keeps us alive.

Menounos, Morgan Stanley: And the gist of what you were saying before is that in your view regulators are getting more comfortable with additional tier one as an asset class, the market capacity for the product, etc.

Schotkamp, BBVA: Yes, the validity of it, the true loss-absorbing nature, yes.

Menounos, Morgan Stanley: But they don’t want to necessarily test it.

Schotkamp, BBVA: Where I was going is that since it is evolving from something that nobody believed really would ever work, it seems to be working and I kind of like it, and there’s an interest that you fill up the bucket, isn’t there? Don’t kill the animal.

Menounos, Morgan Stanley: And access to market to some extent is correlated with how the product per-forms.

Schotkamp, BBVA: From the conversations I’ve had with the people in our joint supervisory team, which I’m not sure is a representative view, I sense there’s an apprecia-tion that this mechanical way of thinking about things, you want to rethink.

You want to rethink when you actually switch off

Khalid Krim MORGAN STANLEY



28 Bank Capital

the coupon, which is from breaching minimum capital requirements to recovery to everything that’s wrong, but once in the recovery zone, probably the regulator would want to see your recovery plan before they tell you to switch off.

Krim, Morgan Stanley: We did spend some time think-ing about how to implement CRR and CRD IV, in an AT1 context trying to get some comfort from regulators on the seniority of claim. In other words, remember we discussed it before with no stoppers, not pushers in AT1. As an AT1 buyer you’re exposed to full discretion and you cannot give the option to the issuer to pay a dividend and then not pay an AT1 coupon.

We did see an evolution in terms of the way our regu-lators gave the issuers the ability to go on the road and explain to the AT1 buyers that they could signal or com-municate that seniority would be respected in terms of cancellation of coupon. So telling investors that we can choose to first cancel the bonuses, then the dividends and then the AT1 afterwards, wasn’t in the regulation or in the technical standards from the EBA, but regulators around Europe were pragmatic and comfortable with this kind of messaging.

Menounos, Morgan Stanley: How do investors feel? Bruno, what do you think?

Duarte, Claren Road: What we do, and it’s served us very well over time, is to focus on the country. What is the relationship between the national and the European regulators, as well as the issuer and the national regula-tor? Some countries are still a bit more lenient, and then it’s down to the bank’s fundamentals.

Whenever you look at this issue, what we take com-fort from is, well, how much buffer do you have if you’re an investment bank? How much is your deferred comp? How much is variable pay?

And then when you get actually down to the size of the AT1 coupon, you think, if AT1s are making up just 1.5% of the total capital base, but their coupons are only 5%-10% of pre-tax profit, the bank probably doesn’t want to impinge on that coupon.

When we potentially might have an issue is when a bank somewhere takes a significant fourth quarter hit and needs its board to approve the accounts. All of a sudden, paying that coupon as a percent of what is left could be quite chunky.

That’s when the nature and structure of the coupon is important. Is it a quarterly coupon, is it a full year cou-pon, is there flexibility, what’s the volatility of the P&L? If you bear all these factors in mind when making that investment decision, we think we should end up with those securities we’re very comfortable holding and probably have less of those that are more volatile.

Somewhere down the line, we don’t know when, a weaker bank will not be able to pay an AT1 coupon and that’s a watershed moment for how developed this asset class is. Will it be treated as an isolated event or not?

We’ve heard the view out there is that on this event, the whole asset class is down 15 to 20 points. We don’t want to believe that, but clearly it is something we’ll only know when we get there.

: Khalid, you started to mention bail-in. How has that changed investors’ lives? Do you feel you have enough information to know what your risk is at each level of the capital structure, particularly now in tier two?

Lustig, L&G: No, we don’t have enough information. A very good example is TLAC. When the first rules came out, tier two underperformed. Then when investors understood that it probably didn’t mean massive issu-ance of tier two, it outperformed.

From our perspective, if I think about bail-in I pretty much think about the hierarchy of capital and where I sit within the claim waterfall and the level of subordina-tion below me.

With regard to TLAC, from a creditor perspective we want it to follow several key principles. Firstly, the solution doesn’t violate our property rights. Secondly, it makes a clear distinction between existing senior debt and bail-inable debt, or TLAC-eligible debt. And lastly, it does not subordinate our existing senior debt.

We are quite comfortable with tier two now, but as regulation is evolving and changing the claim waterfall, then there is less certainty about what is bail-inable and the level of subordination below us.

: Is it frustrating to operate in this environ-ment, when you look at, say, the US capital regulation and see how much simpler it is?

Lustig, L&G: Yes, it’s certainly frustrating. Just in Europe we have the UK and Switzerland that adopted the hold-co solution for TLAC. This solution is clear as it is pure structural subordination.

Then we have the Germans going on a statutory law change solution, something that we don’t really like, as it violates property rights because it would apply retroactively to outstanding securities. And Spain, for example, changed the Spanish insolvency law to permit tier three debt.

But, for most European countries, it’s not clear exactly what would be the eventual TLAC solution. If you need to invest today and you don’t know where you are in the ranking of claims, whether your property rights will be violated, it’s quite hard to price risk correctly and to invest in senior debt and maybe even in tier two debt.

Menounos, Morgan Stanley: Rogier, perhaps in your case you have a simpler view, how do you see it?

Everwijn, Rabobank: We try to make it simple. To Dan’s point, the regulation is actually reasonably clear but I think in the end it’s the resolution authority who will decide how you will fill up your buffers. So you can, as per the German proposal, amend the law such that some chunks of the senior unsecured are MREL or TLAC-eligible, but the regulator can’t force you to issue capital instruments.

Dan Lustig LEGAL & GENERAL ASSET MANAGEMENT



Bank Capital 29

In our situation, it’s pretty clear that we simply want to fill up all the buffers with capital, simply to avoid sen-ior unsecured being bailed in. One of the reasons is the price, but also I think more importantly the availability of senior funding going forward.

: Do investors feel that the German pro-posal can pose a threat to the availability of senior unsecured, as Rogier put it, maybe not in normal course of business but under stress? Does that change the ball game?

Butler, Rogge: It could do, but it really depends on the nature of the issuer. This is the problem with the assess-ment of senior debt and the potential changes — banks’ business models are different. For some, wholesale fund-ing is part of their core funding if you like, and that’s a very different discussion to a bank that really doesn’t need it. So the outcomes for the two are potentially drastically different in terms of the way they run their businesses.

Dodson, Acheivement: I’d agree with that.

Menounos, Morgan Stanley: And is there room for tier three? From an investor perspective, imagine a new asset class which sits between senior and tier two, has different characteristics in terms of the duration, perhaps a shorter-dated instrument whose only purpose is to absorb in a bail-in scenario. Is it an investable product?

Duarte, Claren Road: There’s a bit of a paradox, because to Erik’s point, if the whole aim of Europe is to stand-ardise and to make things simple, then creating a new asset class, even if it does have its advantages for certain jurisdictions for reasons we all understand, we’re scepti-cal whether the issuer will get the benefit.

In the UK two years ago a UK bank issued CoCos that a couple of months later no longer completely served the purpose they had been issued for.

So we believe issuers need to be slightly cautious of the fact that you might bring a new product, which all of a sudden might not get the full intended benefit, or it doesn’t price or trade the way it was envisaged to. In the meantime, the bank’s capital structure has been compli-cated by adding a new layer.

Look at how simple the US banks’ capital structure is. There are three very clear, defined buckets. If Europe is going down this route of, let’s simplify and standardise regulations, we’re not convinced that tier three — even though there are some merits to it — might be the solu-tion some are thinking it might be.

Bian, BlackRock: If you create a new asset class, a subor-dinated asset class, and I say, ‘OK, that’s your new way of TLAC funding going forward’, how does the investor base actually change?

So, if you were thinking before that you had to do €500bn of tier two capital, now you have to do €500bn of tier three capital. Do you have a hybrid sort of asset management community that would say, ‘OK, no way tier two, but, yes, tier three’s great?’ And especially at the beginning where tier three would be very much like tier two, until you build a huge buffer, it should in terms of loss given default be pretty much the same thing. So, do you actually solve that issuance problem by creating this new asset class?

Lustig, L&G: So what is the difference then between a UK bank that moves all its senior debt from the opco to the holdco and a European bank that moves it from senior to tier three? From my perspective, it is the same thing. One is structurally subordinated, the other one is contractually subordinated. I don’t have a problem with that. Then it is for us to price this risk, and I believe the issuer will get some benefits from T3 and we will probably have some benefits, such as a clear distinction between senior term funding and bail-inable debt.

Menounos, Morgan Stanley: And the German proposal, does that price at the same level too?

Lustig, L&G: In terms of pricing, theoretically it should. But I don’t think that investors will be fully com-pensated for a scenario where a statutory solution is adopted. In my view, the pricing for senior unsecured debt should be determined by the level of subordina-tion below the asset class and the thickness of the senior asset class. We’ve seen the German banks repricing with the German proposals and they would have to fund at more expensive spreads.

Dodson, Achievement: One observation I’d make is that, to date, the market has become quite bad at pricing indi-vidual issuers’ capital structures for the thickness of each piece of the capital structure. It’s very important to con-sider that thickness, because we’ve had examples where if you are the tier two holder and there is no AT1 in the capital stack, then guess what, you’re in the AT1 hot seat to some extent when it comes to absorbing losses.

Yet at the time of issuance that deal seems to get away with coming at a tier two-type level, because I don’t think people are clued up enough on the impact of the capital stack thickness. In some ways tier three is maybe an attempt to optimise that market inefficiency by slip-ping in an asset class that comes in tighter than tier two, but if there is no tier two or not a sufficient amount of tier two in someone’s capital structure, fundamentally it probably shouldn’t.

Lustig, L&G: Commenting on this point, you just spoke about loss given default, but not about the probability of default. When a new tier two deal comes to the market the most important thing from our perspective is the probability of default, rather than the loss given default. The probability of default is driven by the underlying credit fundamentals of the issuer.

Aspden, GSAM: Rating is the other thing that no one’s mentioned, which to some extent offers you that infor-mation, in terms of thickness of tranche. Where there is clearly a different bucket of ratings, say triple-B versus single-A, I think you do get some pricing differential.

David Butler ROGGE GLOBAL PARTNERS



30 Bank Capital

Krim, Morgan Stanley: When we speak to issuers around Europe and regulators, I think they all expect the banks to have a layer of equity, CET1, then AT1, then tier two, and a debate could come in terms of total capital strategy or bail-in strategy. Once you have all those buffers in place, it’s about what you need to put in place for the purpose of bail-in, and that depends on the country.

Banks with holding companies will focus on holdco senior debt. Those in countries where there is a statuto-ry solution will debate whether this should be tier two, issuing tier two because they believe it’s more efficient to just top up with tier two. Others will prefer to have a layer in between.

In our conversations, the layer in between is not a substitute for tier two, it is making sure that we have something on top of tier two that is buffering up senior. When I speak to regulators and issuers the question I find hard to answer is: how much do investors, senior unsecured creditors, want to see? What is the right num-ber? What is the expectation? Is it 15%, 17%, 18%, 20%?

The Financial Stability Board has come out with its proposals, the range is 16%-20% of RWAs, plus buffers. From the investor perspective and from a credit perspec-tive, we also know the rating agencies are important.

But a question I have for investors is: what is the number? Maybe it’s bank by bank, how do you look at it from your perspective? We have had banks like Rabobank giving some indication about total capital strategy. Are you getting the information you want?

Aspden, GSAM: You’re almost asking the wrong inves-tors — for investors that are going to get bailed in, how much of the bail-in debt do they want issued? You need to ask the person that benefits from the bail-in: how much do you need to protect you?

Krim, Morgan Stanley: But then who’s benefiting from the bail-in? The equity investors are gone.

Aspden, GSAM: Well that’s why regulators are needing it, because they’re the ones protecting the taxpayers and depositors.

Menounos, Morgan Stanley: But is that the real issue? Perhaps the difference, fundamentally, between the German proposal, holdco senior and tier three is that with tier three there is a specific amount which is meant to buffer senior unsecured, whereas the holdco senior solution — assuming you migrate funding from opco to holdco — and the German proposal lead to senior unse-cured effectively absorbing losses.

Loss given default may be limited but all holders will be affected. Are you suggesting that you would find it more palatable to invest knowing that there is a specific buffer, such that your senior unsecured is not touched?

Aspden, GSAM: Not at all. I’m saying that whatever a bank decides to do, our job is to price that and that’s what we would do.

Schotkamp, BBVA: But that’s unfortunately for issuers not good enough. The day things go wrong, we need to know what it means for our liquidity management, because the bank is going to roll over from a liquidity problem and not from a capital problem.

And if our liquidity instruments turn into capital instruments because investors suddenly don’t like too many of them and effectively stop buying, we may want to take this into consideration.

Are investors still going to be there as a buyer or are they going to strike? And that difference is determined by how much comfort they have. I need a degree of vis-ibility on that view from investors, to go home and artic-ulate what our strategy is going to be, because otherwise what we’re going to be doing, we’re going to be incred-ibly opportunistic and choose the cheapest insurance policy for our funeral.

Dodson, Achievement: I would push back, Erik, and say I totally understand where you’re coming from, but for us to make that assessment, we need to understand how the regulator is going to behave in that situation as well. I appreciate I’m just passing the buck here. But unfor-tunately one thing that’s been fairly consistent about European banks that have got into trouble over the last few years, and this applies across multiple European jurisdictions, is the regulatory outcome in each instance has often differed, not only from what was previously done in a different jurisdiction but, indeed, from what reading the rules at face value you would have expected the regulator to do in that scenario.

: Is national discretion one of the biggest problems for investors? Not understanding what might happen in each country for any given institution that runs into trouble?

Duarte, Claren Road: That’s definitely one reason why we continue to say you have to understand the national regulations and the bank’s relationship with the domes-tic regulator, and then focus on the fundamentals of the bank. It’s always been a three-pronged approach, and remains that way for us.

The few cases in Europe, as Toby says, could not have been read across from one to another. They were in dif-ferent jurisdictions, different business models, different fundamental relationships and it was not straightforward to figure out what was going to happen.

Schotkamp, BBVA: Imagine that the European resolution authority is up and running, the powers are centralised in Frankfurt, so this regulator is not only supervisory but it works together with the single resolution board that will process resolution plans.

Then it turns out that senior bonds are going to be bailed in. A country that has €90bn of senior unsecured bonds outstanding in its financial system, some with retail holders, if you pull the plug on one, that may start a panic in all of them. You have to ask the question, does it provoke a systemic reaction?

What you will find is that for the bail-in that is pro-

Bruno Duarte CLAREN ROAD ASSET MANAGEMENT



Bank Capital 31

posed, that theoretically is an instrument now, you’ve got to go to the supreme court of that country to fight and to see if this holds up versus national law.

Thinking about that real situation, you need a much more hard and determined line than this idea that senior goes in and then everybody shares, but we don’t know how much. I’m just sensing that once we get there, it’s much more difficult to apply the rules.

If you listen to the Bank of England’s Andrew Gra-cie, one of the structural objectives of what he wants to achieve is not only that the bail-in is implemented by law, but that it is executable. I sense that he’s going to completely recognise that this back door solution from Germany somehow does not completely fit the bill of what they really were thinking about. That could well be a tailspin at the end of the whole TLAC proposal.

Everwijn, Rabobank: Coming back to the question of tier three versus German proposal, if you had to choose between the two, then it’s better to have one additional instrument where the investor base clearly knows what they are buying. Then in the event it might happen, then you avoid all kinds of supreme court cases. You should stay away from the whole senior stack, especially as proposed by Germany. Don’t change the rules during the game. You sold it as senior unsecured, you’re pari passu with all the other liabilities. Make it that way, con-tinue that way and then, if you want to, invent a new instrument, like has been proposed in Spain.

Duarte, Claren Road: But it then comes down to if you have a bank that is sufficiently profitable, where it can bear the cost of a tier two or three instrument, then it can issue that. But it is different for an entity in a bank-ing system that is not profitable enough to issue a tier two, or pay an AT1 coupon. It goes back to the point of issuing an instrument that two, three, four years down the line might not be paying.

Menounos, Morgan Stanley: But do you not think that the market is going to reward an issuer that stacks up capital, or creates an additional layer of capital buffer, with tighter pricing in senior debt?

Duarte, Claren Road: The only observation we want to make about tier three, to be clear, is that we just think from the complexity standpoint, we’re not entirely sure whether the bank has enough time or the market is deep enough to issue tier three sufficiently to the point where a new substantial layer of capital has been cre-ated. Until that happens, we think they’re likely to be priced and trading the same.

Everwijn, Rabobank: I see your point, but it’s impor-tant to make a distinction between the two instruments. One is designated for a bail-in, whether that’s tier two or tier three, but the other way is making senior unsecured bail-inable. Regulators should stay away from that.

Duarte, Claren Road: Absolutely.

Lustig, L&G: Tier three gives you a nice reference point for where you are in the hierarchy of claims. If it is just senior debt, you’re not clear where you are in the hierarchy of claims. So, tier three actually makes a clear distinction between senior funding and bail-inable debt. As I said before, I’m OK with structural and contractual subordination, and every solution that doesn’t violate our property rights and doesn’t subordinate existing sen-ior debt. So, I think tier three debt is a simple and clean solution for banks that can’t set up a holdco structure.

Krim, Morgan Stanley: Whether we call it tier three or senior bail-inable debt, does it change anything for your capacity to buy? I’m just looking back to when AT1 start-ed, people were saying we don’t have mandate restric-tions. Do we have the same thing here when we look at senior versus tier three? It won’t be regulatory capital, it just will be something which contractually or statutorily will be junior to senior unsecured debt.

Dodson, Achievement: It becomes quite evident that there is a rationale to capitalise on investment mandates and market technicals to exploit this inefficiency, when people ask: ‘If we call this one thing or call it something else, should it price differently?’

Because if it’s the same thing, whether you call it a pineapple or an orange, it’s the same. We are not restricted in any way by what something is called, but we appreciate that there are investors out there who do have those mandate limitations, and therefore that may affect their behaviour.

Particularly with the creation of a new asset class, the initial pricing should be entirely grounded in fundamen-tals before you can think about whether there is a tech-nical overlay.

And to Rogier’s remark, I do take a lot of sympathy with that view and the view of Bruno that tier three just introduces an additional layer of complexity. For many years we have had something that is meant to serve as going concern loss-absorbing capital. It’s called tier two. I’m not going to say it’s worked well so far because sometimes it hasn’t, but…

: If we were able to wipe the slate clean, as investors which structure would you put in place? Between holdco senior, the German proposal and the creation of tier three, which would be best for investing in bank debt?

Butler, Rogge: Simplicity is key. Conceptually I don’t like the idea of senior debt as a mixture of funding tool and loss absorption tool. That muddies the waters and affects some bank business models more than others.

So if I started from scratch, I think my gone concern loss-absorbing capital would be tier two, and then you have operating liabilities above that. That’s the way we’d do it from our point of view. I think the consen-sus is probably quite positive on tier two in terms of the secondary market or in their asset allocation in banks, because it’s the clearest. There’s more clarity there than there is in other parts of the capital structure.

Erik Schotkamp BBVA



32 Bank Capital

Aspden, GSAM: It’s worth making the point that a lot of the regulators talk about the new world capital struc-tures at end point, and we’re operating in an environ-ment where we’re investing in debt that is transition-ing through. So you’ve got all sorts of different types of ranking and all sorts of different types of bail-in risk, which is quite complex. So a little more guidance on the ranking in transition would be more helpful.

Krim, Morgan Stanley: Are you talking about the rank-ing between legacy and new or internal TLAC, down-streaming, that kind of thing?

Aspden, GSAM: Both would be helpful. Clarity in gen-eral. I meant the first but the second you bring up is an issue we’ve come across as well. Because ultimately, do you really know how it’s been transitioned down?

Everwijn, Rabobank: Something else that’s closely relat-ed to bail-in is asset encumbrance. How much do you take into account the asset encumbrance of an organisa-tion? Is that also in your models? Is it ‘this is the prob-ability of default, if you look at the capital at the bail-in stage, then the potential loss given default is x, but given the amount of asset encumbrance that is x plus 50%’, for example? Is that how you operate as well?

Aspden, GSAM: We certainly take it into account. It depends on the bank as to whether we would look at it in that way. But asset encumbrance is something we would penalise a bank for if they had more of it.

Schotkamp, BBVA: If senior is part of that mechanism of bail-in and the market switches off, probably once the bail-in comes, then the amount of asset encumbrance you’re going to find is going to be dramatic because there are no other sources of funding available.

Bian, BlackRock: It’s asset encumbrance, but it’s also the quality of the assets. Some of the banks that fail, you’d look at their balance sheet one year before they went down, they have non-performing loan ratios of 1% and they are super-clean. Just taking accounting at face value, it’s tricky. So, it’s definitely something to worry about.

: Is TLAC uncertainty the reason tier two supply has disappointed so far this year? From a valuation perspective, is tier two fundamentally still attractive?

Menounos, Morgan Stanley: Run rate tier two supply is down almost 60% this year. What’s been particularly

disappointing is the number of issuers that have come to the market. We’ve seen some fairly chunky supply but from a handful of issuers only so far. Compared to expectations late last year of supply topping €500bn, fuelled by TLAC speculation, it seems like issuers are adopting a more conservative approach.

Aspden, GSAM: Given €500bn has been bandied around, we weren’t excited about all of that issuance, so I wouldn’t say disappointed is the right way to describe how we feel about it now.

Menounos, Morgan Stanley: But if you like bank X and you want to invest in it, which part of the capital struc-ture do you currently prefer? Is there a preference for subordinated debt? Is this a good time to add?

Lustig, L&G: Tier two has its attractions. If you think about it, it’s an asset class of choice for investors which cannot invest in AT1 due to rating or other mandate constraints. Thus, for these investors it’s the way to play the high beta financials.

In terms of pricing, the sub-senior multiple for the index is around 2.3 times. Given that this ratio is a function of the differing recovery rates between senior and sub debt, then the bigger your AT1 buffers are, the more attractive this asset class. It should probably trade below a two times multiple. Therefore, for the risks you’re taking, I think it’s still an attractive asset class.

Bian, BlackRock: I totally agree, it’s very interesting as an asset class. The direction of travel has been very favourable, I can’t deny that. Banks have got much sim-pler, much better capitalised, and in terms of liquidity they’ve got much better as well. Because of occasional funky things in ratings or just a misunderstanding with regard to loss given default as well, you have some dif-ferentials that sometimes don’t make sense.

It is maybe the asset class that misprices the most on loss given default, in a way. There are some issuers with a thin CET1 buffer, no tier one buffer and then they issue tier two at very tight spreads. But then if you already have large CET1 and tier one buffers that’s something that can’t be ignored. You have a historical distribution of losses that you should think about when estimating the impact on a bank’s capital structure from an adverse scenario.

Ceteris paribus, you can’t assume that a 12% CET1 buffer, plus 2% tier one buffer and then a 4% tier two buffer is the same thing as having 10% CET1, no tier one and a 1% tier two buffer. There’s a spread differen-tial that should be applied to that, and it’s not always right that one size fits all is the right way forward.

: Assuming we see the pipeline of AT1 con-tinuing to get done, and we have a little more clarity on TLAC by the end of the year, what are the pitfalls for the next 12 months?

Lustig, L&G: The AT1 asset class should continue to develop over the next 12 months and we’ll see this large amount of issuance continuing, mainly because the benefit of QE is still there and issuers need to fill their 1.5% buckets. As time passes and there is less reg-ulatory uncertainty and more transparency, this should generally be positive for this asset class.

Bian, BlackRock: A year from now we’ll probably be discussing the SREP framework, RWAs, IFRS 9, etc. TLAC and MREL will still be the focus — how do banks

Georgina Aspden GOLDMAN SACHS ASSET MANAGEMENT



Bank Capital 33

plan to get there? We’re still not at the end of that road. It makes our job very interesting and makes the issuers’ job interesting too, I’m sure, and stressful at times. This is not stopping now. A new AT1 asset class is evolving, it is going to be around €200bn in total. It’s very excit-ing times.

Duarte, Claren Road: One year from today we may see a much bigger differential between the haves and the have nots. We don’t think we’re getting that now because there are still a lot of situations in flux in Europe.

Over the next six months we’re going to see clo-sure on some of them. In 2011 stress tests were about Spain, in 2014 they were about Italy. In 2016 they are probably going to be focused somewhere north of Italy and there are going to be a lot of question marks raised about some of the business models there. Some of those regions have issued AT1s or are thinking about it. That’s when we should really get an acid test for the AT1 space.

It should come down to picking out the winners from the losers because we do think there will be some acci-dents taking place in Europe over the next six to nine months and it’s going to make us reassess completely what bail-in is all about.

Butler, Rogge: Come back in a year’s time and we’ll be talking about regulation. That will still be a key theme. I think risk-weighted asset inflation, fundamental review of the trading book, depending on the bank can be quite significant. One thing we shouldn’t underestimate is the difficulty of secondary market liquidity now. We talk about supply and whether we can absorb it, but it’s not so much about whether we like the bank or the asset class any more. It’s if a new issue comes along, can we actually effect switches, for example, in the second-ary market?

For the first time I can remember this year, there have been times when we think the switches we would probably do to participate in this new issue we literally can’t do.

Dodson, Achievement: I’d agree that regulation will definitely have moved on in the next 12 months and there’ll be some interesting new data points to digest. But ultimately we will still be talking about regulation, whether it’s the trading book review, whether it’s RWA harmonisation, whether it’s Liikanen, whether it’s a review of the Bank Recovery and Resolution Directive in Europe.

It’s a simple observation that the more issuers of AT1

we have out there, the higher the probability for an accident is, and therefore the closer we are to the asset class seeing its first true test. I don’t preclude that hap-pening in the next 12 months. It’s not something you look forward to, but I think it’s something we’re very inter-ested to see how that affects both that individual institu-tion, the individual instrument, but also the asset class as a whole.

Aspden, GSAM: Hopefully we’ll be in a better place next year, with a little more clarity on regulation. I agree, it’s still going to be outstanding and the risk weight harmo-nisation is an issue. But it means banks will still hold more capital, so that’s a better place — whether it means issuance and opportunities in that, or just stronger fun-damentals. So I’m quite bullish.

Everwijn, Rabobank: What I hope is that we will have harmonisation across the way we deal with bail-in, pref-erably with the Rabobank method. We have conversa-tions with investors, not just from the continent or from London, but also elsewhere in the world, and for them it’s a complete mess what’s going on in Europe. So I hope from a transparency point of view that we harmo-nise the way we fill up our MREL and TLAC buffers.

Schotkamp, BBVA: Unfortunately the next 12 months are going to be much more dominated by regulatory news, and the ambitions of the ECB as a regulator to be on par with the Fed, the Swiss and the UK.

I am sometimes surprised to see how bullish equity investors are. The amount of push to get this indus-try better capitalised is still mind-boggling. That’s good news, as Georgina says, for the credit fundamentals.

I’m worried about TLAC. I’m really worried about a policy mistake there. This is the overshoot of capital reg-ulation threatening liquidity management, asset income and all these things.

To make a very specific observation, are we going to be able to create regulatory equivalence with our Latin American countries’ regulators, to make TLAC enforce-able and implementable in a multiple point of entry resolution strategy? I don’t know.

Bian, BlackRock: You’ll be forced to shrink at that point, right?

Schotkamp, BBVA: I’ve hinted at strategic decisions. If you don’t have good market positions in non-equivalent regimes, then you’re going to be under pressure. Is it worth the complexity? But then again, that is the agenda of the regulator, to reduce complexity. s

Leopold Bian BLACKROCK

Rogier Everwijn RABOBANK



THE AT1 INVESTOR BASE THE AT1 INVESTOR BASE

IN THE LAST 12 months volatility has come close to going out of fashion.

On October 15, US 10 year Treas-ury yields dropped 37bp, a bigger decline than the day Lehman Broth-ers filed for bankruptcy, before quick-ly rebounding. In January, the Swiss National Bank briefly sent the franc 41% higher against the euro after abandoning the peg between the two currencies.

When the IMF published its Global Financial Stability Report in April these phenomena were afforded their own subheading — ‘When market liquidity vanishes’.

Shortly after that report was pub-lished the 10 year German Bund yield, which had fallen from 0.54% in January to around a tenth of that yield by mid-April, started to witness some of the most violent intraday moves in its history and had pushed above 1% by mid-June.

All the while, one market has increasingly been displaying the kind of stability unthinkable a couple of years ago, when “AT1s are off by a two or three points” was a well-worn phrase in the capital markets on any given morning.

“The lack of volatility in the AT1 market has struck me,” says Andrew Fraser, investment direc-tor for credit at Standard Life Investments.

“Despite the rates sell-off and the concerns around Greece the AT1 market has held in rela-tively well, where in the past it would have been far more volatile. If you look at the spreads on AT1 now they are close to year tights. I’m not saying that’s going to continue but so far it has been impressive.”

In its formative months the AT1 market was the plaything of hedge funds, who were relying on oscil-

lations in perceived value for returns. But given time to study the new struc-tures, larger asset managers have become comfortable with the risks and are now dominating allocations.

Wider audienceThe shocking thing is how much weaker the perception of the AT1 investor base is than the reality, even among those who are actually playing in the asset class on a regular basis.

A Morgan Stanley survey of AT1 investors in April showed 38% of respondents believed hedge funds were the biggest holders of the prod-uct, compared to just 23% of those who thought it was asset managers. In fact, the actual holdings of those surveyed showed asset managers held 72% of the market, with hedge funds trailing on 19%. The US bank estimates this survey of 192 investors captured around half of the AT1 buy-side.

“One thing that may be driving the lack of volatility is that 50% of the investors we surveyed were looking at spreads and 50% at outright yield,” says Jackie Ineke, managing direc-tor, fixed income financial research at Morgan Stanley.

“The larger asset managers tend to

look at spreads. I’ve been surprised by how well AT1s have performed recently, but it might be because a lot more people are investing on a spread basis than before.”

BlueBay Asset Management offi-cially added its name to that buyside in January with the launch of a dedi-cated contingent convertible bond fund, joining more than 20 Europe-an-based funds that have a specific, though not exclusive, focus on bank capital. They include Pimco, the big-gest at around $5.5bn, Swisscanto, Assenagon Asset Management, Alge-bris Investments, Goldman Sachs Asset Management and Cairn Capital.

BlueBay had been investing in CoCos since 2002, but theirs is one of the first funds to focus on new style capital instruments, which it described as “a new asset class with complex features that we believe are not necessarily priced efficiently by the market”.

A wider investor base more likely to hold on to bonds has meant AT1 issu-ers no longer have to wait for a risk-on market to print.

Take Santander UK’s debut transac-tion, a £750m high trigger perpetual non-call seven trade priced on June 3, for example.

“The Santander UK trans-action came on the back of a 20bp sell-off in the 10 year Gilt, and we had 330 inves-tors and a £5bn book,” says Claus Skrumsager, co-head of global capital markets EMEA at Morgan Stanley.

“That tells you that not only is there an enormous investor base, but that the investor base is also curren-cy agnostic. The investors are ready to show up in size, the issuers are the ones holding back.”

Days after Santander UK, BNP Paribas and Bank of Ire-land both printed their own

Europe’s idiosyncratic post-crisis bank capital structures may be tough to navigate, but investors have wised up and with volatility declining, real money is running out of excuses to stay away from additional tier one, writes Tom Porter.

A volatile asset class? Get real

0

4

8

12

16

20

24

28

4

5

6

7

8

Average Core AT1 performance

Average Core € AT1 Performance Yield (LHS) VIX Volatility Index (RHS) Primary Market AT1 Volume (€ bn)

Average Core $AT1 Performance Yield (LHS)

1.3 Bn 1.5 Bn

12.0 Bn

3.0 Bn 5.0 Bn

6.5 Bn

0.2 Bn

9.0 Bn

2.4 Bn 1.5 Bn

8.2 Bn

5.5 Bn

2.1 Bn 0.1 Bn

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May

AT1 yield (%)

Average core AT1 performance


034-35 AT1 Investor base.indd 34 06/07/2015 09:10


THE AT1 INVESTOR BASE THE AT1 INVESTOR BASE

euro denominated debuts in a week when the German Bund broke 1% for the first time since September 2014 and the market forced a 10 year hold-co senior bond from Credit Suisse to be pulled.

Barriers to entryWhile investors are showing up in greater numbers and with bigger war chests — some 60% of the survey respondents with aggregate credit funds over €5bn said they had filled less than 10% of their capacity — Europe’s answer to post-crisis loss absorbing capital has created a dis-jointed market with a range of struc-tures that can be difficult for new buyers to get their heads round.

AT1s from continental Europe, the UK, Switzerland and Scandinavia all have regional nuances from a regula-tory perspective, and banks can pick and mix on call date structures and loss absorbing features.

The three most recent transactions mentioned above highlight the lack of standardisation. Santander UK’s was a perpetual non-call seven with permanent writedown at a 7% com-mon equity tier one trigger, BNP Pari-bas’s featured temporary writedown at a 5.125% trigger in the same matu-rity, while Bank of Ireland went for the same loss absorbency features as BNP Paribas but with a non-call five format.

Purely from a man hours perspec-tive, an investor would have been hard pressed to do the credit work on all three in the space of a week.

“These differing structures have not helped us as investors,” says Standard Life’s Fraser. “You would hope that as a result of all this regula-tion we would see capital structures become simpler, but we have got more bifurcation in capital instru-ments.

“I don’t see the AT1 market yet in a position to price in much of a differ-ence between a five year and seven year call date. People still look at the underlying government bond rate to get to the coupon.”

The quirks of European bank capi-tal are perhaps best viewed from the other side of the Atlantic, where US regulators built a much simpler capi-tal structure post-crisis, comprising vanilla bullet tier two and a cumula-tive preferred product for tier one.

As a result, US capital transactions

are priced relative to an outstanding curve rather than on a deal by deal, or issuer by issuer basis.

The biggest frustration for the US investor base is that each time a new European deal comes out, they need to break out a spreadsheet showing every existing deal and the differences between the local struc-tures, be it UK, continental Europe-an, Swiss or Scandi. That can make it difficult to trade the secondary market with any kind of profitable speed.

“Europe’s non-standardised market means that US investors need to put in the homework to find a structure’s value, and the savvier investors are doing just that,” says Edward Hodg-son, head of US investment grade debt syndicate at Morgan Stanley.

European banks may have had a bigger investor base much sooner if regulators had taken the US route. But the reality is that Europe consists of member states rather than federal ones. The non-standardised market is here to stay.

And when ING is able to bring in $26bn of orders for a dual tranche non-call five and non-call 10 dollar deal, designed to appeal to Asian and US investors respectively, it is hard to argue that European banks are still missing out.

“Could you make the argument that structural idiosyncrasies held up the development of this market? Sure,” says Scott Ashby, head of FIG DCM Americas at Morgan Stanley.

“But three years ago we were doing meetings where US investors said they would never even value this risk, so the market has come a long way in a very short time. That is a posi-tive for European banks looking at US markets.”

The tipping pointWhile a daunting array of structures probably narrowed the investor base for the first handful of trades, the pace of entry into the market has now quickened.

Just 11% of those surveyed by Mor-gan Stanley were unable to invest in AT1, and more than half of them were in the process of getting the necessary approval. Some 8% of the respondents could not participate in the market just 12 months ago.

“In my view it’s quite extraordi-nary that we have different struc-

tures across Europe, with various loss absorbing features, but still investors are engaged and willing to buy the AT1 product,” says Khalid Krim, head of EMEA capital solutions at Morgan Stanley.

“The lack of harmonisation is bal-anced by the fact that people are able to look at this issuer by issuer, coun-try by country, and are comfortable.”

Bankers say the rewards should be there for those who take the plunge. Trading since the start of the rates sell-off suggests spreads could tighten in response to rising underlying rates, rather than yields widening to main-tain the current spread levels.

“This is a cheap asset class,” says Skrumsager. “Why would you buy a double-B rated corporate at 3%-4% versus an additional tier one at 5%-6%, when you know that banks have increased their core tier one cap-ital ratios by 50% or more in the last three or four years?”

Deals from the some of the best capitalised banks in Europe have struggled to perform once they trade south of the 5% barrier. So what is keeping this attractive investment cheap? The quantum of AT1 yet to come is one big factor, as is the lack of true buy and hold investors that will eventually come in, take product off the market and help squeeze spreads.

But that moment isn’t too far away, says Skrumsager.

“There is some inertia, especially among the larger real money inves-tors, and for good reason,” he says.

“They have only been looking at this for one or two years. When you survey investors they say they are very interested and they have dedi-cated funds to the asset class, but they also admit they haven’t really invested yet.

“We are at a tipping point where investors are ready to take the next step and get in for real.” s

“I’ve been surprised by how well AT1s have performed

recently, but it might be because a lot more people are

investing on a spread basis than before”

Jackie Ineke, Morgan Stanley

034-35 AT1 Investor base.indd 35 06/07/2015 09:10


INVESTOR SURVEY INVESTOR SURVEY

The charts and information included in the following pages have been extracted from a piece published by Morgan Stanley’s European Banks Research team on May 20, 2015 entitled ‘AT1 – The Investor Base’. The research piece was published on the back of an AT1 survey conducted independently by Morgan Stanley’s Fixed Income Research department in April 2015. The extracts included here are for illustrative purposes only and selected to provide a recent perspective of the AT1 investor base. For the avoidance of doubt, these information points do not constitute Morgan Stanley Research and should not be considered as a Morgan Stanley research publication.

Polling the AT1 investor base

Family o�ices/professional investors/private bank customers - 18%

Banks - 8%

Insurers - 9%

Pension funds - 4%

Asset managers - 23%

Hedge funds - 38%

Do not have to sell, but cannot add to the position - 62%

Sell, but within a longer time frame than 3 months - 19%

Sell within three months - 19%

Asset manager - 72%

Hedge fund - 19%

Banks - 9%

Not benchmarked against an index - 19%

Other - 5%

Markit iBoxx - 9%

JP Morgan - 1%

Citigroup - 1%

BofA Merrill Lynch - 28%

Barclays Capital - 37%

I have no more capacity - 3%

50-100% - 10%

25-50% - 12%

10-25% - 15%

0-10% - 60%

€500m - 15%

€250m - 13%

€100m - 8%

No restrictions - 62%

No limit - 33%

25-50% - 3%

10-25% - 10%

5-10% - 16%

0-5% - 38%

1

2

4

5

6

9

8


Banks - 8%

Insurers - 9%

Pension funds - 4%


Hedge funds - 38%




Asset manager - 72%

Hedge fund - 19%

Banks - 9%


Other - 5%

Markit iBoxx - 9%

JP Morgan - 1%

Citigroup - 1%




50-100% - 10%

25-50% - 12%

10-25% - 15%

0-10% - 60%

€500m - 15%

€250m - 13%

€100m - 8%


No limit - 33%

25-50% - 3%

10-25% - 10%

5-10% - 16%

0-5% - 38%

1

2

4

5

6

9

8


Banks - 8%

Insurers - 9%

Pension funds - 4%


Hedge funds - 38%




Asset manager - 72%

Hedge fund - 19%

Banks - 9%


Other - 5%

Markit iBoxx - 9%

JP Morgan - 1%

Citigroup - 1%




50-100% - 10%

25-50% - 12%

10-25% - 15%

0-10% - 60%

€500m - 15%

€250m - 13%

€100m - 8%


No limit - 33%

25-50% - 3%

10-25% - 10%

5-10% - 16%

0-5% - 38%

1

2

4

5

6

9

8


Banks - 8%

Insurers - 9%

Pension funds - 4%


Hedge funds - 38%




Asset manager - 72%

Hedge fund - 19%

Banks - 9%


Other - 5%

Markit iBoxx - 9%

JP Morgan - 1%

Citigroup - 1%




50-100% - 10%

25-50% - 12%

10-25% - 15%

0-10% - 60%

€500m - 15%

€250m - 13%

€100m - 8%


No limit - 33%

25-50% - 3%

10-25% - 10%

5-10% - 16%

0-5% - 38%

1

2

4

5

6

9

8

3

11

12

13

14

7

10

0

20

40

60

80

100

NoYes, but I don't own any Yes

OverallUSEuropeAsia

0

20

40

60

80

100Too volatile

Unsuitable for my funds

Not a fixed income instrument

Overpriced considering the risks

OverallUSEuropeAsia

0

20

40

60

80

100

YieldCredit spreads

OverallUSEuropeAsia0

20

40

60

80

100

>€5bn€500m-€1bn€0-50m

OverallUSEuropeAsia

0

30

60

90

120

150 HY Corp alternatives

Tier 2 Debt level

Senior debt level

CDS level

Equity dividend yield

54321

0

20

40

60

%

%

%

%

%%

%

80

100

Likely that AT1s are triggered before a bank hits PoNV

Likely that only high-trigger AT1s are triggered before a bank hits PoNV; 5.125% triggers are likely to be hit

A bank will hit PoNV before any AT1 trigger is hit

OverallUSEuropeAsia

75

80

85

90

95

100

NoYes, and all ratings must be IGYes, but the average ratings must be IG

OverallUSEuropeAsia

10085

44

88

15 19 23 251219

129

17

69

24

18

18

27

112

28

28

24

31

31

31

31

18

127137

57

14

56

15

92 86 91

3

6

2

8 10

5

13

52 70 54

56 48 30 46

88 9

22

70

13

38

50 35

33

3219

43

38 36

34

2997

100

100 45 50

13

38 18

810

14

31 26

47

90 77 89

74

2391


Banks - 8%

Insurers - 9%

Pension funds - 4%


Hedge funds - 38%




Asset manager - 72%

Hedge fund - 19%

Banks - 9%


Other - 5%

Markit iBoxx - 9%

JP Morgan - 1%

Citigroup - 1%




50-100% - 10%

25-50% - 12%

10-25% - 15%

0-10% - 60%

€500m - 15%

€250m - 13%

€100m - 8%


No limit - 33%

25-50% - 3%

10-25% - 10%

5-10% - 16%

0-5% - 38%

1

2

4

5

6

9

8

Perception: who do respondents think own AT1? Reality: actual AT1 holdings of our respondents

What’s the minimum deal size required? What percentage of your funds can be in AT1?

Are you able to invest in AT1s? Which index are you benchmarked against?

Source: Morgan Stanley Research Source: Morgan Stanley Research



036-37 investor survey.indd 36 06/07/2015 09:11


INVESTOR SURVEY INVESTOR SURVEY

3

11

12

13

14

7

10

0

20

40

60

80

100


OverallUSEuropeAsia

0

20

40

60

80

100Too volatile




OverallUSEuropeAsia

0

20

40

60

80

100

YieldCredit spreads


20

40

60

80

100

>€5bn€500m-€1bn€0-50m

OverallUSEuropeAsia

0

30

60

90

120


Tier 2 Debt level

Senior debt level

CDS level


54321

0

20

40

60

%

%

%

%

%%

%

80

100




OverallUSEuropeAsia

75

80

85

90

95

100


OverallUSEuropeAsia

10085

44

88

15 19 23 251219

129

17

69

24

18

18

27

112

28

28

24

31

31

31

31

18

127137

57

14

56

15

92 86 91

3

6

2

8 10

5

13

52 70 54

56 48 30 46

88 9

22

70

13

38

50 35

33

3219

43

38 36

34

2997

100

100 45 50

13

38 18

810

14

31 26

47

90 77 89

74

2391

3

11

12

13

14

7

10

0

20

40

60

80

100


OverallUSEuropeAsia

0

20

40

60

80

100Too volatile




OverallUSEuropeAsia

0

20

40

60

80

100

YieldCredit spreads


20

40

60

80

100

>€5bn€500m-€1bn€0-50m

OverallUSEuropeAsia

0

30

60

90

120


Tier 2 Debt level

Senior debt level

CDS level


54321

0

20

40

60

%

%

%

%

%%

%

80

100




OverallUSEuropeAsia

75

80

85

90

95

100


OverallUSEuropeAsia

10085

44

88

15 19 23 251219

129

17

69

24

18

18

27

112

28

28

24

31

31

31

31

18

127137

57

14

56

15

92 86 91

3

6

2

8 10

5

13

52 70 54

56 48 30 46

88 9

22

70

13

38

50 35

33

3219

43

38 36

34

2997

100

100 45 50

13

38 18

810

14

31 26

47

90 77 89

74

2391

3

11

12

13

14

7

10

0

20

40

60

80

100


OverallUSEuropeAsia

0

20

40

60

80

100Too volatile




OverallUSEuropeAsia

0

20

40

60

80

100

YieldCredit spreads


20

40

60

80

100

>€5bn€500m-€1bn€0-50m

OverallUSEuropeAsia

0

30

60

90

120


Tier 2 Debt level

Senior debt level

CDS level


54321

0

20

40

60

%

%

%

%

%%

%

80

100




OverallUSEuropeAsia

75

80

85

90

95

100


OverallUSEuropeAsia

10085

44

88

15 19 23 251219

129

17

69

24

18

18

27

112

28

28

24

31

31

31

31

18

127137

57

14

56

15

92 86 91

3

6

2

8 10

5

13

52 70 54

56 48 30 46

88 9

22

70

13

38

50 35

33

3219

43

38 36

34

2997

100

100 45 50

13

38 18

810

14

31 26

47

90 77 89

74

2391

3

11

12

13

14

7

10

0

20

40

60

80

100


OverallUSEuropeAsia

0

20

40

60

80

100Too volatile




OverallUSEuropeAsia

0

20

40

60

80

100

YieldCredit spreads


20

40

60

80

100

>€5bn€500m-€1bn€0-50m

OverallUSEuropeAsia

0

30

60

90

120


Tier 2 Debt level

Senior debt level

CDS level


54321

0

20

40

60

%

%

%

%

%%

%

80

100




OverallUSEuropeAsia

75

80

85

90

95

100


OverallUSEuropeAsia

10085

44

88

15 19 23 251219

129

17

69

24

18

18

27

112

28

28

24

31

31

31

31

18

127137

57

14

56

15

92 86 91

3

6

2

8 10

5

13

52 70 54

56 48 30 46

88 9

22

70

13

38

50 35

33

3219

43

38 36

34

2997

100

100 45 50

13

38 18

810

14

31 26

47

90 77 89

74

2391


Banks - 8%

Insurers - 9%

Pension funds - 4%


Hedge funds - 38%




Asset manager - 72%

Hedge fund - 19%

Banks - 9%


Other - 5%

Markit iBoxx - 9%

JP Morgan - 1%

Citigroup - 1%




50-100% - 10%

25-50% - 12%

10-25% - 15%

0-10% - 60%

€500m - 15%

€250m - 13%

€100m - 8%


No limit - 33%

25-50% - 3%

10-25% - 10%

5-10% - 16%

0-5% - 38%

1

2

4

5

6

9

8

3

11

12

13

14

7

10

0

20

40

60

80

100


OverallUSEuropeAsia

0

20

40

60

80

100Too volatile




OverallUSEuropeAsia

0

20

40

60

80

100

YieldCredit spreads


20

40

60

80

100

>€5bn€500m-€1bn€0-50m

OverallUSEuropeAsia

0

30

60

90

120


Tier 2 Debt level

Senior debt level

CDS level


54321

0

20

40

60

%

%

%

%

%%

%

80

100




OverallUSEuropeAsia

75

80

85

90

95

100


OverallUSEuropeAsia

10085

44

88

15 19 23 251219

129

17

69

24

18

18

27

112

28

28

24

31

31

31

31

18

127137

57

14

56

15

92 86 91

3

6

2

8 10

5

13

52 70 54

56 48 30 46

88 9

22

70

13

38

50 35

33

3219

43

38 36

34

2997

100

100 45 50

13

38 18

810

14

31 26

47

90 77 89

74

2391

3

11

12

13

14

7

10

0

20

40

60

80

100


OverallUSEuropeAsia

0

20

40

60

80

100Too volatile




OverallUSEuropeAsia

0

20

40

60

80

100

YieldCredit spreads


20

40

60

80

100

>€5bn€500m-€1bn€0-50m

OverallUSEuropeAsia

0

30

60

90

120


Tier 2 Debt level

Senior debt level

CDS level


54321

0

20

40

60

%

%

%

%

%%

%

80

100




OverallUSEuropeAsia

75

80

85

90

95

100


OverallUSEuropeAsia

10085

44

88

15 19 23 251219

129

17

69

24

18

18

27

112

28

28

24

31

31

31

31

18

127137

57

14

56

15

92 86 91

3

6

2

8 10

5

13

52 70 54

56 48 30 46

88 9

22

70

13

38

50 35

33

3219

43

38 36

34

2997

100

100 45 50

13

38 18

810

14

31 26

47

90 77 89

74

2391


Banks - 8%

Insurers - 9%

Pension funds - 4%


Hedge funds - 38%




Asset manager - 72%

Hedge fund - 19%

Banks - 9%


Other - 5%

Markit iBoxx - 9%

JP Morgan - 1%

Citigroup - 1%




50-100% - 10%

25-50% - 12%

10-25% - 15%

0-10% - 60%

€500m - 15%

€250m - 13%

€100m - 8%


No limit - 33%

25-50% - 3%

10-25% - 10%

5-10% - 16%

0-5% - 38%

1

2

4

5

6

9

8

Which metrics are most important for AT1 valuation? (1 = most important to 5 = not important)

Which statement best describes your view?

How do you value AT1? Can you only buy AT1s that are investment grade?

What happens when an IG rating is lost? If you can invest but don’t own any AT1, why not?

How much AT1 do you currently hold? How much of your AT1 capacity have you filled?





036-37 investor survey.indd 37 06/07/2015 09:11


RATINGS RATINGS

THE AVERAGE RATING of a Euro-pean bank before the crisis was AA+, while a significant minority had tri-ple-A ratings across multiple agen-cies. Now, the average rating is BBB+, while more than a few institutions are in junk territory, dragged down by collapsing sovereign ratings, dismal macro conditions, and their own idi-osyncratic troubles.

Yet this stream of downgrades came against a backdrop of banks becoming stronger. Virtually every institution in Europe has issued new hybrids designed to bear losses, raised new equity, or retained huge chunks of earnings.

In the five years after 2008, the top 20 European banks issued €147bn in new common stock, and retained €102bn in earnings, according to the European Banking Authority.

But still the downgrades kept com-ing. As fast as banks shored up their balance sheets, rating agencies identi-fied new sources of risk and changed their criteria for banks to follow news flow and regulation.

End of the downgrades?Now, however, the downgrades might be coming to a close. The final piece of the puzzle was the introduction of bail-in in Europe. Investors which used to provide funding to banks now provide gone-concern capital, while investors in capital notes know they

are more vulnerable than ever if a bank goes down.

The agencies have taken different approaches to including these bail-in powers in their ratings, but the big three — Moody’s, Standard & Poor’s, and Fitch — have made big changes in this regard over the last year or so.

But they have also, to their credit, started to take into account the work that banks have done to make them-selves more resilient to a crisis, and more resolvable if they do go down.

While senior debtholders might end up bailed in, liability holders, which used to be pari passu with senior bonds, now have a fat layer of protection underneath them in a bank resolution.

The banks can also look forward to an improving economic backdrop, and the next round of rating changes could be positive.

“Banks have faced significant pres-sure on their ratings for several years now,” says Austen Koles-Boudreaux, head of FIG rating advisory at Morgan Stanley. “With the economic environ-ment improving, however, along with the significant progress many banks have made in strengthening their bal-ance sheets, 2015 may hopefully be the turning point for downgrades and ratings stability.”

No more single ratingsIn recent times, the homogeneous bank rating has fallen out of favour.

Different layers of capital in differ-ent parts of the corporate structure are now treated differently. Certain categories of liability, such as deriva-tives and deposits, have been moved up, while covered bonds are privileged across Europe. The agencies, rightly, take different approaches to these dif-ferent categories of bank liability.

Moody’s has gone furthest in reflecting the new reality. It has introduced a “loss given failure” framework, to reflect the importance

of regulators and resolution in imposing losses.

This means Moody’s now offers sep-arate ratings for a bank as a counter-party, or as a deposit-taker, as well as for its senior debt, sub debt, covered bonds and short term debt.

“The Moody’s revised criteria was overall received positively — particu-larly the loss given failure framework, which recognises that large volumes of subordinated (or holding company) instruments can protect more senior creditors from bail-in when a bank fails, and that this should be reflected in banks’ senior and deposit ratings,” says Koles-Boudreaux.

Fitch has taken a simpler approach, but spent about a year stripping out sovereign support assumptions from its bank ratings, culminating in down-grades for 44 European banks at the end of May.

The agency says that virtually no EU or Swiss banks have any sovereign support embedded in their ratings.

“There is some uncertainty about how all EU member states will man-age to implement the Bank Resolution and Recovery Directive into nation-al legislation, but Fitch understands from discussions with national regula-tors and bank management that this has more to do with practical impedi-ments of the national legislative pro-cess or priorities than any political resistance,” says the agency.

But it blunted the impact of strip-ping out sovereign support by noting the work that banks had done to bol-ster their balance sheets, and there-fore increased the “viability rating” of the banks (this level is one input, with sovereign or parent support, into the overall “issuer default rating”).

Fitch does not just flag up capital raising and more junior debt as mak-ing banks stronger — it says some features of the new regulatory regime itself have helped support ratings.

“Recovery plans are an important

After a turbulent few years, the bottom is now in sight for bank ratings. As bank creditors have become bank capital providers, banks have been downgraded again and again, while agencies have thrown out and redrafted their criteria. Owen Sanderson reports.

Waiting for the capital raisings and recovery regimes to pay off

“2015 may hopefully be the turning point for downgrades and

ratings stability”

Austen Koles-Boudreaux,

Morgan Stanley

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RATINGS RATINGS

feature of the BRRD,” says the agency. “If recovery plans work and supervi-sors step in early enough to prevent a bank’s deterioration to the point of non-viability, its VR and consequently IDR are unlikely to fall to levels deeply into sub-investment grade.”

S&P has also taken a simple approach, rather than rebuilding its criteria from scratch.

After the total loss-absorbing capac-ity (TLAC) proposals were published in November, S&P started a consulta-tion on how it should treat this poten-tial extra buffer layer.

Unhelpfully, this gave the FIG mar-ket the acronym ALAC (additional loss-absorbing capacity) to sit along-side TLAC and the UK’s PLAC (prima-ry loss-absorbing capacity).

The ALAC approach, in essence, acknowledges the same point as the other agencies — a fat buffer of loss-absorbing junior debt will protect sen-ior debt in a resolution.

S&P has been more cautious than Fitch in stripping sovereign sup-port out of its ratings — though it has applied its new principles to UK, Ger-man, Austrian and Swiss banks, it has not yet done so right across Europe.

The BRRD is European law, and theoretically applies everywhere. But it has yet to be transposed to national law in all jurisdictions.

S&P says: “We regard the UK and German regimes as having a resolu-tion process for systemic banks that is sufficiently well defined to allow for the effective recapitalisation of a fail-ing systemic bank.”

For Fitch though, “the bail-in tool… has to be implemented into all national legisla-tion well within Fitch’s short-term rating hori-zon”, meaning Fitch has rolled out bail-in assumptions for every jurisdiction.

Different scopes for different folksSmaller agencies like Scope, which has been making a lot of noise about having a differ-ent approach to rat-ings, have also been responding to the new regulations, though their market share

remains tiny in Europe.Scope says that it already counts

TLAC debt in its issuer strength rat-ing, so using this to notch up long term ratings even more could be “a form of double counting”. It says that even if a bank has qualifying TLAC or MREL liabilities that were “very mate-rial”, it would not notch a bank up from its issuer strength assessment.

“We welcome having more rating agencies involved, which should lead to a greater diversity of credit opin-ions and would optimally mean that banks are not limited to using the big three,” says Koles-Boudreaux. “That said, it will likely take a long time before there is a fully competitive rat-ing agency landscape.”

Still work to doThough long term ratings receive the most investor and media attention, some of the most important work to do is at the short end.

Short term ratings arguably affect banks most profoundly. The money market funds and short term investors that buy bank commercial paper are more ratings-sensitive than the long term bond funds in senior debt, while short term ratings also affect a bank’s ability to act as a trading counterparty, offer undrawn liquidity, and a host of other banking tasks.

“Despite the recent crisis, ratings remain critical for banks — beyond funding costs, they remain the ‘nuts and bolts’ of the financial system, baked into the short term markets,

money markets, derivative contracts and a large number of other areas,” says Koles-Boudreaux.

Paradoxically, the approach of the major agencies to short term rat-ings has been least responsive to the new regulation. Short term debt — below one year maturity — is effec-tively excluded from bail-in, for the very good reason that hosing short term investors would lock a recover-ing bank out of the funding markets just when it needed funding most. But rather than being treated as a privi-leged liability class, short term ratings are largely tied to senior debt ratings.

“We would welcome a more refined approach by the rating agencies for determining bank short term ratings, which are largely mapped from the long term equivalent,” says Koles-Boudreaux. “If a bank’s short term rat-ing is downgraded to A-2 from A-1, for example, access to short term funding can become restricted; this is not nec-essarily the case when the long term rating is lowered to A- from A.”

While the current criteria for bank ratings may still fall short, there will of course be further revisions as banks get more regulatory clarity.

Banks can expect certainty about the calibrations of TLAC and MREL this year, countries will tighten up their legal frameworks for bail in, and banks will start to indicate how they plan to meet the new structures.

Rating agencies have rolled with the regulatory punches so far, but there’s plenty more still to do. s

PRA Example: Adjusted BCA of baa3, Operational Resolution Regime (going concern) Source: Moody’s Investors Service

Instrument class De jure De facto Assigned LGF notching

Additional notching

Total Instrument Notching

Preliminary Rating

Assessment

Counterparty Risk Assessment (CRA) 3 3 3 0 3 a3 (cr)

Deposits 2 3 2 0 2 baa1

Bank senior unsecured long-term debt 2 0 1 0 1 baa2

Holding company senior unsecured long-term debt -1 -1 -1 0 -1 ba1

Bank dated subordinated debt -1 -1 -1 0 -1 ba1

Bank non-cumulative preference shares -1 -1 -1 -2 -3 ba3

LGF Notching

PRA example: adjusted BCA of Baa3, Operational Resolution Regime (going concern) The table below shows the difference the new Moody’s methodology makes — and how the agency balances the existence of a resolution law (de jure) with the likelihood of it actually being used (de facto). Taking the bank’s credit quality, the Baseline Credit Assessment, as a starting point, privileged liabilities, such as derivatives (the Counterparty Risk Rating) and deposits, are notched further up than in the past. Holding company debt, sub debt and preference shares are pushed down further, since they are supposed to absorb losses better than in the past.

Source: Moody’s Investors Service

038-39 Rating Advisoryv2.indd 39 06/07/2015 09:11


LIABILITY MANAGEMENT

IN 2015, LIABILITY management for financial institutions has been a strange market. Russian banks, the Northern Rock bad bank, Deutsche Pfandbriefbank and the Italian national champions have all made appearances, but all have idiosyncratic challenges.

Santander UK offered a welcome piece of business when it tendered for legacy capital notes alongside its new additional tier one, announced at the end of May, but this hardly heralds a pick-up in activity — it is a simple bank subsidiary in a jurisdiction with plenty of regulatory clarity, a clear approach to resolution, with plans to float in the not-too-distant future.

“Liability management this year is very selective, banks need to look at the run-off profile and grandfathering arrangements for outstanding capital notes,” says Khalid Krim, head of EMEA capital solutions at Morgan Stanley.

Banks are sitting on their hands for two reasons.

First, it’s no longer a good trade. In the years after the crisis, all forms of bank debt were hit hard — but banks were handed bountiful quantities of cheap liquidity from central banks. Naturally, some of this went to shoring up capital, through buying and retiring old funding instruments.

Capital, ABS, senior and covered bonds all benefitted from this trend, with capital notes hit in the early years, followed by the Iberian and Italian banks buying back swathes of ABS during 2012-2013. Some of the tenders didn’t work too well — investors, even then, were not necessarily willing to sell, and many had bought the bonds at new issue, rather than at distressed levels.

But banks did want to do the trade, at least.

Now, with interest rates on the floor and QE coursing through the market’s veins, fixed rate bonds are

way over par and floaters back at issue levels. Pre-crisis debt has mostly matured, and there are few opportunities to buy on the cheap.

“In the immediate post-crisis years, banks were able to buy back their old capital below par, and generate core capital by retiring it,” says Krim. “But at current trading levels that is over.”

Yet to kick inBut the next big driver for liability management has yet to kick in.

This will be the package of capital rules associated with a bank resolution — TLAC (total loss-absorbing capacity) for the big banks, MREL (minimum required eligible liabilities) for all European banks, with regional variants such as PLAC (primary loss absorbing capacity) in the UK.

The resolution rules also dictated where the capital is held. Holding companies are to be preferred, since they allow for a “single point of entry” on resolution — the home regulator of the bank handles the whole resolution. Banks also prefer this, for the most part, since it means less trapped capital in subsidiaries. Only institutions with huge numbers of separately capitalised subsidiaries already, such as Santander and HSBC, are likely to opt for a “multiple point of entry” resolution plan.

Several big banks, including Credit Suisse and Barclays, have started building curves for debt from their holding companies. The UK and Switzerland have been particularly helpful jurisdictions in this respect — although their rules are tougher than the EU-level or G20-driven plans for capital and resolution, their banks have had certainty for some time about how they will look, and in the UK at least, the banks already had holding companies, from which they issued their equity.

“UK and Swiss banks know they

can use holdco structures, but it’s the right approach for them to first establish pricing with new issues,” says Krim. “It’s a bit early to try to flip opco holders into holdco in one big bang transaction, you want observable, established market prices.”

He continues: “Santander UK’s combined holdco AT1 issuance and legacy opco T1 buyback is about eliminating inefficient capital, transferring capital at the holdco, and accelerating the migration to a structure which works with the UK resolution process.”

Holding company senior debt will definitely count as TLAC debt, whatever other tweaks are included, so it is a smart move, where certainty exists. Starting to issue now will vastly simplify any liability management down the road which aims to flip investors from the operating company debt, where most presently sit, into the holding company.

Getting clarityClarity on how resolution will work in practice ought to help. Following publication of the TLAC paper, many argued that holding company senior unsecured was structurally subordinated to operating company senior unsecured — it would be possible to bail in holding company senior and not operating company senior.

Liability management for financial institutions has had a quiet time of it in 2015. Banks spent the post-crisis years buying back debt to generate capital, and will spend the years ahead fitting their capital stack to the new regulatory reality. But for now, the market is becalmed. Owen Sanderson reports.

Sitting on their hands: banks and liability management

“Liability management this

year is very selective, banks need to look at the run-off profile and grandfathering

arrangements for outstanding capital

notes”

Khalid Krim, Morgan Stanley


LIABILITY MANAGEMENT

But it now seems that senior debt will be treated equally wherever it sits in the structure. The ‘No Credit Worse Off’ principle means that all creditors at a given level in the capital stack, whether they sit at holding company or operating company level, should be treated the same. The purpose of the holding company, therefore, is just a convenient grouping for resolution purposes, not a way to push certain bondholders lower in the capital structure.

“There was a lot of confusion when TLAC first came out, which wasn’t helped by reckless statements from policymakers,” says Krim. “In a resolution scenario, whether you lend at opco or holdco level, you will be treated the same. There will be a resolution waterfall, which will hit capital first, and then senior. As investors understand this, they might actually prefer to take the spread premium you get for holdco debt.”

This will help to get large scale liability managements done in practice.

One worry when the TLAC proposals were first announced was the problem of being a “first mover” to becoming a holding company creditor. If holdco debt was suborinated to opco debt, the first bonds in the holdco would be wiped out for sure in a resolution, with the loss given failure coming down gradually as other bondholders switched over.

In a liability management, this would have created a prisoner's dilemma — if you don’t switch from opco to holdco but everyone else does, you move up the capital stack and are left with a safer bond.

However, with many investors still hunting for a few basis points of extra yield, tempting them into the holdco may be less challenging.

Other jurisdictions, such as Germany, have opted for a statutory solution to the TLAC dilemma. Germany has passed a law declaring all senior debt, regardless of issue conditions or contractual language, to be bail-inable TLAC debt — wiping away, at a stroke, the issue for German banks.

New senior debt might still include contractual warnings, or a mention of the law as a risk factor, but the big German banks now see TLAC as a non-issue.

For jurisdictions that don’t pass such a law and do not have holding companies for their banks, contractual change might be an option. But this, too, is likely to take the new issue, followed by exchange or tender route, rather than a consent solicitation to change the bond terms directly.

“A consent solicitation needs a higher level of approval, and the outcome can be binary,” says Krim. “It seems like an easy, clean way to switch an issue from opco to holdco, but if you get a low take-up, or don’t meet quorum, the solicitation fails. In an exchange, you aren’t imposing the decision on other investors, you’re just offering it to investors that want to take it.”

More urgencyNext year, too, banks will start to feel more urgency about their legacy capital. The European Union’s Capital Requirements Directive IV has arrangements for grandfathering non-compliant tier one and tier two debt, whereby these instruments lose 10% regulatory capital credit every year they are outstanding.

“There will also be bigger inefficiencies in keeping old capital in place,” says Krim. “Right now banks get 70% credit, but next year it will be 60%, then 50%. When you get into that zone, you need to think about accelerating the transitioning into new capital.”

Many institutions will wait for clarity, but the big Italian banks are already starting to move.

In late June, Intesa exchanged €737.7m of old tier two for €782m of new notes, while UniCredit repurchased €1bn of outstanding tier two.

UniCredit said: “The bonds were the target of a repurchase effort given the fact that they no longer qualified for tier two regulatory treatment and were thus inefficient from a balance sheet management perspective.”

Many of the legacy capital notes have some sort of regulatory call built in (often a tax call as well), allowing issuers to call at 100 or 101 if they lose regulatory capital credit.

But this approach risks angering investors if the notes are trading above that level. Lloyds tried to call its ECNs at par, arguing that the UK’s Prudential Regulatory Authority had not counted them as capital for its stress testing process. But a judge threw it out, saying that the PRA could easily include them in future stress tests.

Hard numbersThe most important change, however, will be hard numbers on TLAC and a hard term sheet for MREL. Banks right now can run contingency plans, but until they have exact detail, they cannot target large scale liability managements to clean up their capital stack and prepare for the new regime.

“It’s tricky to retire debt or upgrade debt if you don’t know the calibration of capital regulations, and banks are still waiting on certainty on MREL and TLAC,” says Krim. s

Santander UK and Barclays will be printing holdco debt in the future

© 2015 Morgan Stanley. All rights reserved. This communication does not constitute an offer to sell or the solicitation of an offer to buy any securities. Morgan Stanley and/or any of its affiliates may hold proprietary interests in any of the securities referred to in this document.

Morgan Stanley & Co. International plc is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and Prudential Regulation Authority. This document is for informational purposes only and is directed only at persons who (i) have professional experience in matters relating to investments falling within article 19(1) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 or (ii) are persons falling within article 49(2)(a) to (d) of that Order (high net worth companies, unincorporated associations, etc.) or (iii) persons outside the United Kingdom (all such persons together being referred to as “relevant persons”). This document must not be acted on or relied on by persons who are not relevant persons. Any investment or investment activity to which this document relates is available only to relevant persons and will be engaged in only with relevant persons.

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KBC

€750 MM 1.875% 12NC7Tier 2Joint Bookrunner — March 2015

Bank of Ireland

€750 MM 7.375% PerpNC–5Additional Tier 1Joint Bookrunner — June 2015

Santander UK

£750 MM 7.375% PerpNC–7Additional Tier 1Joint Bookrunner — June 2015

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€1,500 MM 5.50% PerpNC–5.5Additional Tier 1Joint Bookrunner — January 2015

Societe Generale

¥43,600 MM ¥27,800 MM 2.20% 10yr Bullet ¥13,300 MM 1.89% 10NC5 ¥2,500 MM 10yr FRN

Tier 2Joint Bookrunner — March 2015

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