FINSAC WORKSHOP ON BAIL-IN AND MREL: Case studies and ...pubdocs.worldbank.org/.../5-Ismael-Ahmad-13Dec2016.pdf · FINSAC WORKSHOP ON BAIL-IN AND MREL: Case studies and Group work

FINSAC WORKSHOP ON BAIL-IN AND MREL: Case studies and Group work

DECEMBER 13, 2016VIENNA, AUSTRIA

Speaker: Mr Ismael AhmadVENUE: WORLD BANK OFFICEPraterstrasse 31, 1020 Vienna, Austria21st Floor

2

Introduction

Scenario events overview

Case study


1. Preliminary remarks

3

1. This case study deals with a situation by which a well-capitalized and highly liquid bank suffers a progressive deteriorationof its capital and liquidity position, due mainly to an unsupportive macro environment.

2. The supervisor gradually takes measures against the bank, first of all downgrading the SREP rating of the bank. Later,requires the bank to come with a overall restructuring plan to improve its situation.

3. As the restructuring plan fails, the bank is forced to look for more radical solutions (a rights issue or a takeover). Theresolution authority is gradually getting more involved with the bank.

4. As the private sector solution fails, the bank is put into resolution by the supervisory authority. Since the bank isconsidered a systemic institution in the country, the resolution authority decides to apply an open bank bail-in resolutionstrategy to the entity, converting junior and senior debtholders into shares.


Parent company in a

EU country

Asset management

company

Life insurance company

100% 100%

The Bank of the East

a

b c

2. Corporate structure and description of the Group

4

a. The Bank of the East; that acts both as the parent

company and the main operating company. It is

the fourth bank in the country by assets and its

main business are retail and commercial banking.

Its mainly funded through deposits, though it also

issues mortgage covered bonds.

b. The Insurer of the East. This is a 100% owned

subsidiary of The Bank of the East. Its main

business its the underwriting of life insurance

policies. It reinvest the premiums in public and

corporate bonds. It also has deposited its excess

liquidity in its parent company. The polices are

distributed through the branch network of their

parent company.

c. The Asset Manager of the East. This company

manages several funds (money market, equity and

mixed funds). The funds are offered to clients

mainly through the branch network of the parent

company.

“The Bank of the East” is the parent company of a financial group. The

group is made up by the following companies:a

b

c

5

Introduction


Case study


Resolution CAGR

Assets 26,900 21,090 18,893 17,893 -13%Mortgage Loans 12,000 11,000 10,000 9,000 -9%NPLs 800 2,600 3,000 4,000 71%Customers deposits 15,600 12,250 8,500 8,500 -18%Tangible equity 2,800 2,240 1,293 293 -53%

NPL (%) 4.0% 14.1% 18.8% 25.0% 84%NPL coverage (%) 37.5% 30.8% 50.0% 62.5% 19%Gross Margin/TA (%)

2.0% 1.7% 1.4% 0.8% -27%

ROA (%) -0.7% -6.4% -5.0% -5.8% 103%Loan-to-Deposits (%)

126.9% 150.2% 188.1% 188.1% 14%

CET1 (%) 16.1% 10.5% 2.8% -6.3% -173%MREL (%) 35.6% 20.3% 15.1% 6.6% -43%

3. Scenario events overview

6

Early intervention measures are

requested

Business as usual

Situation is deteriorating

Situation is deteriorated

Resolution

Following the determination

by the supervisor, the bank is

declared non-viable

(FOLTF)

The resolution authority places the

Bank under resolution and then applies

in accordance with the resolution plan, the

bail-in tool

Year 1 Year 2 Year 3

In year 3 the bank keeps losing

money, mainly because of the bad performance of the

NII and the high credit impairments

In July (year 3) the resolution authority asks the supervisor

for more information

CET1 ratio of 2.8%, which is materially lower than its SREP.

Valuation is conducted

Overall SREP score

for is “3” (the risks

identified pose a

medium level of

risk to the viability)

and the score for

business model

and strategy is “4”

More radical solutions

requested. Partner for a

merger is seeked


• Profitability: NIM and operating profit have declined for 2 years ina row. In Y2, the operating profit barely covers the overheads. Inaddition, the bank had to book significant one-off charges for legacylitigation issues related to the miss-selling of insurance andinvestment products.

• Asset quality: the increase in non performing exposures has forcedthe bank to book large net credit losses in the period, which by noware high enough to threaten the bank´s viability. NPL coverage ratio

has decrease significantly, raising doubts over the credibility of thesolvency of the bank.

• Liquidity: due to the loss of several core funding sources (i.e.:deposits withdrawals, non-renewal of wholesale issuances) the bankhas been forced to increase its reliance in the ECB funding

• Capital: the significant losses booked in the period have reduceddramatically the capital ratios of the bank; triggering the non-compliance of the bank with its combined buffer requirement (2.5%).Although impacted by the capital depletion, the MREL ratio is stillstrong enough to be seen as one of the strong points of the bank

Financial drivers

4. From year 1 to year 2

7

Liabilities Y1 Y2

Term deposits 5,000 4,000

Sight deposits 10,600 8,250

Reverse repos 2,500 1,000

ECB funding 2,000 3,500

Provisions 300 700

Senior bonds 2,500 1,000

Sub bonds 400 400

Reserves 2,600 1,240

Capital 1,000 1,000

LIABILITIES 26,900 21,090

The evolution, as shown in the balance sheet and in the P&L accounthas been very adverse in the last 2 years. Even tough the bankstarted the period with a sound capital and liquidity position, thesituation has deteriorated. This has prompted the supervisor todowngrade the bank from SREP 2 to SREP 3 due concerns on capitaland viability of the business model.

In early year 2, the supervisor, using its early intervention measuresas foreseen by the BRRD, required the bank to draw up arestructuring plan (see following slide) with a number of measures toenhance the solvency, profitability, risk profile and the liquidity andfunding position of the bank.

Assets Y1 Y2Mortgage Loans 12,000 11,000

SME loans 4,000 2,800

Corporate loans 3,000 2,000

Government bonds 5,000 2,000Central bank deposits 1,000 600

Intangible assets 800 0Non performing loans 800 2,600

Provisions on NPLs (300) (800)Deferred tax assets 100 440

Insurance investment 300 300Fixed assets 200 150

ASSETS 26,900 21,090

Y1 Y2

Interest income 681 523

Interest expenses (341) (354)

Net interest margin 340 169

Fee income 187 178

Dividends 9 9

Net interest income 536 356

Overheads (270) (255)

Operating profit 266 101

Credit impairments (400) (600)

Litigation (100) (400)

Goodwill write-off 0 (800)

PBT (234) (1,699)

Taxes (47) (340)

PAT (187) (1,360)

Ratios Y1 Y2

NPL 4.0% 14.1%NPL coverage 37.5% 30.8%

NIM/TA 1.26% 0.80%Fee income/TA 0.70% 0.84%Overheads/TA 1.00% 1.21%Net margin/TA 0.99% 0.48%Cost of credit 2.02% 3.26%

ROE (5.20%) (60.68%)ROA (0.70%) (6.45%)

RoRWA (1.26%) (9.50%)Leverage 9.34% 7.37%

RWA density 55.4% 67.9%Tangible equity 2,800 2,240Equity-to-assets 10.41% 10.62%

Y1 Y2Capital 1,000 1,000

Reserves 2,600 1,240CET1 deductions (1,200) (740)

Total CET1 2,400 1,501RWA 14,893 14,318

CET1 Ratio 16.1% 10.5%Superavit / deficit

(over 10%) (bp)601 bp 50 bp

Total CET1 2,400 1,501Sub bonds 400 400

Total Capital 2,800 1,901RWA 14,893 14,318

Total Capital Ratio 18.8% 13.3%Superavit / deficit(over 13.5%) (bp)

530 bp -20 bp

Total Capital 2,800 1,901Senior bonds 2,500 1,000Total MREL 5,300 2,901

RWA 14,893 14,318MREL ratio 35.6% 20.3%

Balance Sheet

P&L

Capital ratios Scenario events overview

Business as usual



Resolution



4. From year 1 to year 2: Restructuring Plan

8

Expected impacts on the risk profile

# Nature Details ProfitabilityAsset

qualityLiquidity Capital

1 EfficiencyCost cutting

measures

Reduce the FTEs and the business outlets by 20%. The banktargets a 10% cost base reduction. The bank expects that thecost-cutting measures won´t impact its revenues

2 De-riskingWinding down

the riskier business lines

Wind down the riskier business lines of the bank, mainly (i)the high-loan-to-value retail mortgages and (ii) leveragelending for M&A operations and for corporates with Debt-to-EBITDA higher than 4x. The bank would cease to originatethese assets and would assess the possibility of a portfolio saleto investors if the prices are supportive

3Capital

reinforcement

Strengthening the capital

position

Issuance of €700M of subordinated bonds to retail investorsthrough the commercial network. Some fixed-income fundsmanaged by the AM subsidiary have also buy some bonds

4Liquiditymeasures

Reinforcing of the liquidity and funding position

Securitization of the high-quality mortgage portfolio to issueAAA-rated RMBS to be retained and repoed at the ECBmonetary policy operations. The bank takes measures to stopthe retail deposit outflows

5 OthersInternal

reorganization

The bank has overhauled its management team with the (i)replacement of the CEO, (ii) the appointment of three newnon-executive directors with experience in banking and riskmanagement and (iii) the setting up of a separated NPLworkout line of business

6NPL

reductionDisposals

The bank plans to start a SPA involving between 30-40% ofits NPLs. The bank would try to minimize the impact of thesale in its capital position.

Business as usual



Resolution



• Profitability: the NIM continues to deteriorate due to a lowinterest rate environment, higher funding costs, deleveraging in itsloan book and the increase in NPL. In addition, the reduction inoverheads fails to offset the pressure on revenues. Furthermore,litigation charges continue to be high; proving that they were not aone-off charge.

• Asset quality: Asset quality indicators continue to deteriorateacross all the loan portfolios. In addition, the bank is forced toincrease NPL coverage to levels comparable with its peer group. Thisends up depleting the capital position of the bank, since the bank isforced to take sizeable losses to increase the coverage levels. Thebank is not able to conduct a NPL sale.

• Liquidity: the bank continues to loss core funding sources(especially retail). The loan to deposit ratio increases dramaticallyand the bank runs out of unencumbered liquid assets to coverpotential cash outflows. The liquidity position of the bank inunsustainable.

• Capital: In spite of the placement of subordinated bonds, the lossesdeplete the CET1 of the bank to a level that implies a deep breach ofthe minimum SREP requirement.

In December (year 3), the supervisor decides to declare the bank asnon-viable since it fulfils failing or likely to fail (FOLTF) conditionsoutlined in the BRRD. The resolution authority is permanentlyinformed on the situation.

Financial drivers

5. From year 2 to year 3: non-viability

9

Liabilities Y2 Y3



Reverse repos 1,000 700


Provisions 700 1,000

Senior bonds 1,000 700 *

Sub bonds 400 700

Reserves 1,240 293

Capital 1,000 1,000


Assets Y2 Y3Mortgage Loans 11,000 10,000

SME loans 2,800 1,876


Government bonds 2,000 3,200Central bank deposits 600 100

Intangible assets 0 0Non performing loans 2,600 3,000

Provisions on NPLs (800) (1,500)Deferred tax assets 440 677


ASSETS 21,090 18,893

Y2 Y3




Fee income 178 163

Dividends 9 9



Operating profit 101 16



Goodwill write-off (800) 0

PBT (1,699) (1,184)

Taxes (340) (237)

PAT (1,360) (947)

Ratios Y2 Y3

NPL 14.1% 18.8%NPL coverage 30.8% 50.0%

NIM/TA 0.80% 0.44%Fee income/TA 0.84% 0.86%Overheads/TA 1.21% 1.27%Net margin/TA 0.48% 0.09%Cost of credit 3.26% 5.63%

ROE (60.68%) (73.23%)ROA (6.45%) (5.01%)

RoRWA (9.50%) (8.32%)Leverage 7.37% 1.77%

RWA density 67.9% 60.2%Tangible equity 2,240 1,293Equity-to-assets 10.62% 6.85%

Y2 Y3Capital 1,000 1,000

Reserves 1,240 293CET1 deductions (740) (977)

Total CET1 1,501 317RWA 14,318 11,382

CET1 Ratio 10.5% 2.8%Superavit / deficit

(over 10%) (bp)50 bp -720 bp

Total CET1 1,501 317Sub bonds 400 700

Total Capital 1,901 1,017RWA 14,318 11,382


-20 bp -460 bp

Total Capital 1,901 1,017Senior bonds 1,000 700Total MREL 2,901 1,717

RWA 14,318 11,382MREL ratio 20.3% 15.1%

Balance Sheet

P&L


Business as usual



Resolution


* 100M were sold to retail investors


1. The bank did not comply with the minimum capital requirements. According to the large stock of NPLs, the tight liquidityposition and the evolution of the business, there is no prospect that the bank can return to compliance by its own means.

2. The conversations with potential investors interested in a takeover or a rights issue failed. Hence, the bank cannot raiseequity from the market, and consequently a private solution for the Bank of the East is not possible.

3. The Bank of the East currently has a 5% market share in current accounts, 3% in term deposits and 7% in mortgage loans.All are considered as critical economic functions by both the resolution and the supervisory authority so the bank cannotbe liquidated through ordinary insolvency proceedings and needs to be subject to a resolution special regime.

4. In addition, a potential loss of access of clients to their accounts may spread the contagion to other banks with similarbusiness models, undermining the confidence that the public has in the financial system.

5. Need for intervention

10

Business as usual



Resolution



• Asset Quality: the resolution authority decides to reclassify

€1bn of performing loans to NPLs and to take a €1bn further

provisions both to cover the losses of the reclassified loans and

to increase the coverage of the portfolio to more realistic

levels. The resolution authority decides not to activate the tax

losses triggered by the additional loan losses.

• Capital: the new impairments further deplete the capital

levels. Although the accounting value of equity is still positive,

the CET1 ratio has turned negative, due to the impact of

deductions (DTAs, insurance stakes).

Financial drivers

6. From year 3 to resolution: bail-in

11

Liabilities Y3 Res



Reverse repos 700 700


Provisions 1,000 1,000

Senior bonds 700 700

Sub bonds 700 700

Reserves 293 (707)

Capital 1,000 1,000


Immediately, the resolution authority takes over the bank.

Using the powers the BRRD gives to it; it immediately replaces

the senior management of the bank and mandate an

independent valuation of the bank to two investment firms

(The “so-know” valuation).

Assets Y3 ResMortgage Loans 10,000 9,000

SME loans 1,876 1,876


Government bonds 3,200 3,200Central bank deposits 100 100

Intangible assets 0 0Non performing loans 3,000 4,000

Provisions on NPLs (1,500) (2,500)Deferred tax assets 677 677


ASSETS 18,893 17,893

Y3 Res




Fee income 163 75

Dividends 9 9



Operating profit 16 (10)



Goodwill write-off 0 0

PBT (1,184) (1,302)

Taxes (237) (260)

PAT (947) (1,042)

Ratios Y3 Res

NPL 18.8% 25.0%NPL coverage 50.0% 62.5%

NIM/TA 0.44% 0,30%Fee income/TA 0.86% 0,42%Overheads/TA 1.27% 1,34%Net margin/TA 0.09% (0,57%)Cost of credit 5.63% 5.63%

ROE (73.23%) (355,04%)ROA (5.01%) (5,82%)

RoRWA (8.32%) (9,64%)Leverage 1.77% (5.67%)

RWA density 60.2% 60.4%Tangible equity 1,293 293Equity-to-assets 6.85% 1.64%

Y3 ResCapital 1,000 1,000

Reserves 293 (707)CET1 deductions (977) (977)

Total CET1 317 (683)RWA 11,382 10,807

CET1 Ratio 2.8% (6.3%)Superavit / deficit

(over 10%) (bp)-720 bp -

Total CET1 317 (683)Sub bonds 700 700

Total Capital 1,017 17RWA 11,382 10,807


-460 bp -

Total Capital 1,017 17Senior bonds 700 700Total MREL 1,717 717

RWA 11,382 10,807MREL ratio 15.1% 6.6%

Balance Sheet

P&L


Business as usual



Resolution



6. Resolution decision

12

Business as usual



Resolution


1. Following the determination by the supervisor that the bank is failing or likely to fail (FOLTF), the resolution authorityplaces the Bank under resolution. The systemic nature of the bank prompts the resolution authority to discard a sale ofbusiness and bridge bank resolution strategy. Therefore the bank decides to apply a bail-in resolution strategy

2. The resolution authority prepares a resolution valuation, that, since there has not been enough time to make preparationsis provisional. A definite valuation has to be carried out in the future.

3. At the start of the resolution process, the resolution authority takes the control of the Bank, replacing all the board ofdirectors and assuming all the powers of the shareholder´s general meeting. In addition, replaces the senior managementof the bank and appoints new managers to conduct the resolution of the entity.

FINSAC WORKSHOP ON BAIL-IN AND MREL: Case studies and Group work 13

7. Bail-in

Deficit of loss-absorbency capacity

Capital needed (15%RWA+deductions) (2,304)

Available capital post-resolution (equity+T2) 993

Deficit without senior bonds (1,311)

Senior bonds 700

Final deficit (611)

Checks

Minimum contribution by shareholders and creditors (8%) 1,512

Contribution (including debtholders) 2,693

Contribution needed by the SRF 611

Distribution of the new equity Share of capital

Old equity valuation 50 3.1%

Sub debt valuation (50% face value) 350 21.8%

Senior debt valuation (85% face value) 595 37.0%

Contribution by SRF 611 38.0%

Total 1,606 100%

The NRA’s decision involves:

Reducing the value of the shares and

reserves to 50M according to the valuation

conducted by the independent investment

firm.

The conversion of the subordinated debt

into shares, which is valued at 50% of face

value.

Regarding the senior debt, as more and fresh

capital is needed, a conversion into shares is

also executed. The senior debt is valued at

85% of its face value.

Finally, as the regulatory conditions are met,

the SRB uses the SRF to ensure effective

application of the bail-in tool.

Business as usual



Resolution


14

Introduction


Questions

FINSAC WORKSHOP ON BAIL-IN AND MREL: Case studies and Group work 15

Case study

Group of the East

Deposit splitSight Term

Individuals DGF insured 3,500 800

SME DGF insured 1,000 200

Corporates DGF insured 50 900

Individuals non-DGF insured 500 100

SMEs non-DGF insured 350 -

Intragroup (insurance company) 600 -

Corporates non-DGF insured 500 -

TOTAL 6,500 2,000

Senior debtholders split

Institutionals 600

Retail 100

TOTAL 700

a

b

c

1. Intragroup (insurance company) deposits:

1. What are the effects of converting this claim

into shares?

2. Will you exclude it from bail-in?

2. Corporates non-DGF insured:

1. Explain the pros and cons of subjecting this

claims to bail-in.

2. What problems may be trigger if they are

bailed-in? Is it possible, according to BRRD,

to exclude them from bail-in?

3. Retail senior and junior debtholders:

1. Explain the pros and cons of subjecting these

bondholders to bail-in

2. Is the bail-in of these bondholders an

impediment to resolution? What measures do

you think the resolution authority should

have been taken in the resolution planning

with regard to them?

a

b

c

16

Thank you

Ismael Ahmad Fontán

Partner

Tel.: +34 678 603 458

Email: [email protected]

Documents

FINSAC WORKSHOP ON BAIL-IN AND MREL: Case studies and ...pubdocs.worldbank.org/.../5-Ismael-Ahmad-13Dec2016.pdf · FINSAC WORKSHOP ON BAIL-IN AND MREL: Case studies and Group work