Hybrid Capital IFLR.ppt

iflrwebinar:hybridcapital,february3,2010,ny2668716,agenda,introductioncriticismsofhybridsduringthefinancialcrisiscurrentstateofthehybridmarketareviewofhybridsecuritiesnewdevelopmentsaffectinghybridsregulatorycapitaldiscussionscontingentcapitalpredictions,preferredstockconvertiblepreferredstockreitpreferredequityunits(preferredstock),oldworldstructures,criticismsofhybridsduringthecrisis,priortothefinancialcrisis,financialinstitutionshadbecomereliantonhybridsecuritiesfortheircapitalneedstraditionally,hybridissuershadcalledthesecuritiesatthefirstopportunity;however,facedwithfewsourcesofreplacementcapital,issuerssurprisedinvestorswhentheydidnotcalloutstandinghybridsratingagenciesdowngradedhybridsbasedonabeliefthathybridswouldsufferlossesduringthecrisisandpaymentsonhybridswouldbedeferredbyissuersseekingstateaid,hybridsduringthefinancialcrisis,althoughhybridssufferedlosses,commentatorshaveobservedthatthesesecuritiesdidnotprovetobeas“lossabsorbent”asintendedandthereforedidnotprovidesufficientfinancialflexibilityforthebankissuerstherehasbeenabitofabacklashagainsthybridsecuritiesinvestorshavebecomemorefocusedon“tangiblecommonequity”asameasureoffinancialstrength,newworldstructures,commonstocksurvivinghybridstrustpreferredenhancedtrustpreferredequityunitsspecialsituationscommonequivalentsecuritiescitigroupt-decscontingentcapital,stateofthehybridmarket,subordinatedissuancevolumes2002-2010,subordinatedissuancepeakedin2006-2007period(eur155bnandeur163bnequiv.issued)2008-eur115bnequiv.capitalraisedfromstateinjections,subordinatedsupplyfallstoeur45bnequiv.(down28%frompeak)2009totalcapitalraisedsimilartopre-crisislevels(eur151bnequiv.),subordinatedsupplyaccountingforeur47bnequiv.liabilitymanagementnewissuesaccountedforeur18bnin2009includinggbp7.5bnofnewcontingentcapitalsecurities(lloyds),globalsubordinatedsupplybyyear2002-todate,source:bondware/calyonnotes:inallmajorcurrencies(usd/gbp/eur),subordinatedissuancevolumes2009todate,rapidrecoveryofthesubordinateddebtmarketsin2009re-openingofsubordinatedt1/t2debtmarket:february(bankt1mizuho)may(inst2rsa,bankt1andt2rabobank)july(inshybridprudential)october(corphybridhero)greaterapplicationtoabroaderarrayofissuers/sectorsbanks,insurance,corporates,rated/unratedandemissuers,globalhybriddebtissuance(nongovernmentprovided)byissuertypejan2009-todate,source:bondware/calyon,subordinatedsupplybyissuergeography,europeanissuersactivein2009(66%oftotalsupply)usactivityprimarilyfromsubordinatedissuesplacedinthedomesticmarket(22%oftotalsupply)fallinasianissueractivity(inusd/eur/gbp)asissuerschoosetoaccessthemarketinlocalcurrencies(8%oftotalsupply),globalsubordinateddebtsupplyin2009,source:bondware/calyon.notes:inallmajorcurrencies(usd/gbp/eur),subordinatedsupplybyissuerrating,postcrisismoreaaissuersinthemarket47%oftotaldealsissuedin2009(versus41%in2006)pre-crisisissuancesplitmoreevenlyoverratingbands2009:aa(47%),a(39%),belowa(14%)2006:aa(41%).a(42%),belowa(17%),moodysissuerratingforsubordinatedissuersin2006versus2009,source:bondware/calyon.notes:inallmajorcurrencies(usd/gbp/eur),subordinatedspreaddifferentialscontinuetonarrowthecostsassociatedwiththeriskfactorsforhybridcapital(subordination,deferralrisk,extensionrisk)havefallenfurther,asindicatedbythechartbelow:lt2cost-riskfactors:subordination+extensionrisk(wheretheissueiscallable):now73%lowervsq109ut2cost-riskfactors:subordination+deferralrisk+extensionrisk:now30%lowervsq109t1cost-riskfactors:moresubordination+moredeferralrisk+extensionrisk:now60%lowervsq109,subordinatedspreadsanddifferentials,iboxxbanksecondaryspreaddifferentials,subordinatedspreaddifferentials,source:calyon,source:calyon,evolutionofhybridstructures,contingentcapitalhavealreadybeenissuedinthepastbespokestructuresprovidingone-offsolutionsforissuersnowthemarketwantscommoditisation,liquidityandhedgebility,source:calyon,areviewofhybridsecurities,trustpreferredsenhancedtrustpreferredsequityunits,trustpreferred,financialholdingcompany,delawarestatutorytrust,$100milliontrustpreferredsecurities,common(nominal),$100millionsubordinatedloan,trustpreferred(contd),trustisagrantortrustforfederalincometaxpurposestrustpreferredsecuritiesrepresentaninterestinthe$100millionsubordinatedloan5-yearinterestdeferralonsubordinatedloan(andtrustpreferred)federalreservetreatsastier1capitalforbankholdingcompany(upto25%limit);15%limitfor“internationallyactive”bhcsinterestonsubordinatedloanistaxdeductiblebybankholdingcompany.individualholderstaxedatmaximum35%ordinaryincomeratesoninterest(andoid)interestandoidnotsubjecttou.s.30%withholdingtaxwhenpaidtonon-u.s.investors,enhancedtrustpreferred-cents,financialholdingcompany,delawarestatutorytrust,$100millioncapitalsecurities(cents),common(nominal),$100millionjuniorsubordinatedloan,enhancedtrustpreferredcents(contd),60-yearjuniorsubordinatedloanwith30-yearscheduledmaturitydateequityissuedtorepaysubordinatedloanenhancedinterestdeferralfeaturesinyears5-10essentiallyhassameustaxconsequencestoissuerandholdersasa“regular”trustpreferredofferingmoodys:cordbasketinternalrevenueservice:chiefcounselmemorandum200932049(march10,2009)enhancedtrustpreferredisdebtforfederalincometaxpurposesbasedonviewthatequitylikefeaturesveryunlikelytoeverberelevant.,equityunits(common),financialholdingcompany,5-yearsubordinateddebt,forwardcontractovercommonstock,custodian,unit,investors,equityunits(common),unitnoteandforwardcorporateunitsnotealonetreasuryunitstreasuriesandforwardsubordinatedinterestdeferralremarketsafterthreeyears;rateisreset,commonequivalentsecurities,problem:needcapitalnowbutinsufficientcommonsharesauthorizedundercharter;ashareholdervotecanbeobtainedinaslightlylongertimeframe.preferredstockisauthorizedunderchartersolution:issuepreferredstockunderstatelawthatconvertsintocommonstockwhentheshareholdersauthorizemorecommonstockpreferredstockstermsmirroreconomicsofcommonwithsamedividendrightsascommonsweetners:includeswarranttoacquireadditionalcommonsharesifvotefailsdividendstepupifvoteisdelayed,citigroupt-decs(12/14/09),tangibledividendenhancedcommonstock-givestheinvestorcommonstockexposureplussomethingthatlookslikecurrentincomeinexcessofcurrentcommondividendunitconsistingof:prepaid3yearstockpurchasecontracttobuycommonstockamortizingsubordinatednotewithfinalpaymentduein3years,producesreturnontheinvestorsoriginalissueprice,installmentsaredeferrablebutnotbeyond6yearsallocationofvaluetostockpurchasecontractandtoamortizingnoteunitstradesonexchangecomponentsareseparable,newdevelopments,newdevelopments,bothratingagencieshavebeenstudyinghybridratings.moodyshasalreadyannouncedanewmethodologyfornotching.theecbhaspublishedguidanceon“innovativetier1instruments”thenewbaselframeworkannouncedinmiddecemberwouldphaseouttheuseofvarioushybridinstruments,ratingsandregulatorycapital,moodystoolkit,ratingagencydevelopments,ratingagencydevelopments,moodysguidelines,innovember2009,moodyspublishedguidelinesforratingbankhybridsecuritiesandsubordinateddebttheguidelines:removesystemicandregionalsupportfromhybridratings;provideforwidernotchingamongdifferentclassesofbankhybrids;andprovideflexibilitytopositionhybridratingsbasedoncasespecificandcountryspecificconsiderations,moodysguidelines,asaresultofthemoodysguidelines,moodysloweredratingsfor40%ofhybridsbyoneortwonotches;andloweredratingsfor50%ofhybridsbythreetofournotches,anchorpointforhybridratingsgenerallyremovessystemicsupportandwillbebasedonbanksintrinsicfinancialstrength(the“adjustedbaselinecreditassessment”),moodysrevisedguidelines,regulatorydevelopments,ecbdevelopments,eucapitalrequirementsdirective(crd)implementsthebaseliiaccordintheeuropeaneconomicarea(eea)may2009amendmentstothecrdenactedcommitteeofeuropeanbankingsupervisors(cebs)proposalsforhybridtier1eligibilitycriteriacommondefinitionsofhybridcapitalinstrumentsthatcouldberegardedas“innovative”tier1capital-“principles”typecriteria;importantdetailsmissingthemostimportantfeaturesofhybridtier1instrumentsare:1.permanence2.flexibilityofpaymentslossabsorbencymandatoryconversion,(foreligibilitybeyondthe35%limitunderthecrdamendments).cebslaunchedaconsultationwhichclosedinseptember2009inconjunctionwithitsproposalsformoredetailedguidelinesfornationalbanksupervisorsineurope,undated(orperpetual)instruments-mayprovidefora“moderate”incentivetoredeem,arisingnotearlierthan10yearsafterissuance.recommendationsprovide,wheretheincentiveconsistsof(a)aninterestrate“step-up”step-upcappedat100basispointsor50%oftheinitialcreditspread,lesstheswapspreadbetweentheinitialindexbasisandthestepped-upindexbasis,(b)aprincipalstocksettlementmechanismcoupledwithanissuerredemption(calloption)conversionratiocappedat150%oftheconversionratioatthedatethehybridinstrumentwasissued,and(c)otherincentivestobeassessedbytherelevantnationalbanksupervisorcasebycase.,permanence,(2)datedinstrumentsmusthaveminimummaturityofatleast30yearsandmaynotprovideforanincentivetoredeem.(3)bothundatedanddatedinstrumentshybridswhicharedatedorcontainanincentivetoredeem-limitedtoanaggregatemaximumof15%ofabankstier1capital.maycontainanissuercalloptionexercisableafter5years,butanyredemptionrequiresthepriorconsentofthecompetentauthorityconsentmaybegrantediftherequestingbanksfinancialconditionandsolvencyarenotaffectedconsenttoearlierredemptionmaybegrantedinthecaseofanunforeseenchangeintaxorregulatorytreatment.astodatedinstruments,consentmustbewithheld,orredemptionsuspended,ifissuernon-compliantwithitsregulatorycapitalobligations.,permanence(contd),cebsguidelinesrecommendissuersrequestforconsenttobesupportedby:awell-foundedexplanationofthereasonthereforcurrentsolvencydata,includingthecapitalpositionbeforeandafterredemptionaconfirmationthattheissuerwillremainincompliancewithallregulatoryrequirementsafterredemptiona3-5yearplanforthedevelopmentofsuchsolvencydata,evaluationoftheissuersrisksexposureandthesufficiencyofthetier1capitalleveltocoverthoserisks,includinginstressedcircumstances.iftherelevantauthorityasks,ademonstrationofitsabilitytore-accessthehybridsmarket.consentmustberefusedwhereitwouldputissuersfinancialconditionorsolvencyinmaterialjeopardyintheforeseeablefutureandissuermustmaintainsufficientcapitalbufferslevelsabovetheregulatoryminimum.,permanence(contd),(4)repurchases(“buybacks”)-althoughcrdissilentasto“buybacks”ofhybridinstruments,cebsregardsbuybacksasequivalenttoacallredemption,ineconomicandprudentialtermsmaypermitrepurchasesupto5%oftherelevantissuanceformarket-makingpurposescebsconsideringallowingrepurchases,before5yearsandwithoutreplacement,inlimitedcircumstances,solongastherepurchaseimprovessolvencyofissuer,butsomeconcernsofnationalsupervisorsofpermanencebeingcompromised,permanence(contd),hybridtier1capitalmustgiveissuerabilitytocancel,onanon-cumulativebasis,interest/dividend(“coupon”)paymentsnationalregulatorsmayrequirecancellationofcouponsbasedonissuersfinancialconditionorsolvencycancellationmandatorywhereissuerinbreachofitsregulatorycapitalrequirementsexemptionavailableforhybridcontaininganalternativecouponsatisfactionmechanism(“acsm”oralternativepaymentmechanism),i.e.,permissibletoissuesharesinlieuofcouponpaymentbutnationalregulatorscanimposeconditionsonsuchsubstitutions,flexibilityofpayments,cebsguidanceondividendpushers/dividendstoppers(notaddressedbycrd).a“dividendpusher”requirestheissuertopaythehybridcouponifitpaysadividendonitscommonstock;conversely,a“dividendstopper”preventstheissuerfrompayingadividendoncommonstockunlessitalsopaysthehybridcoupon.accordingtocebs,adividendpusherisapermissiblefeatureofhybridtier1capital,butmustbewaivedif:betweenthedateofthecouponpushandthedateforpayment,issuerbreachesitsregulatorycapitalrequirementsthecompetentauthorityrequirescancellationofthecouponbasedonfinancialcondition/solvencyconcerns,orthemajorityofthedividendoncommonstockispaidinshares,ratherthancash,flexibilityofpayments(contd),asregardsadividendstopper,cebshasonlynoteditshouldnothinderrecapitalisationcebsregardsanacsmasacceptableonlyifitachievesthesameeconomicresultasacancellationofthecoupon(i.e.,nodecreaseincapital),meaningthatthedeferredcouponsmustbesatisfiedwithoutdelayusingnewlyissuedsharesuptoanequivalentaggregatefairvalue(atamaximum)hybridholdersmustbeartheriskthatsellingthosesharesmaynotyieldthesubstitutedcouponamountinfullacsmshouldnothinderrecapitalisation,i.e.,theissuershouldbeabletocanceltheacsminordertoabsorblossescebsdidnotclarifywhetherissuercouldsellthesubstitutedsharesonbehalfofthehybridholdersandpaythemthenetcashproceeds-leftuptothenationalsupervisors.,flexibilityofpayments(contd),undercrd,hybridsmustbeabletoabsorblossesbothona“goingconcern”basisandinaliquidation,andtocountastier1capital,maybesenioronlytocommonstockandnothavebenefitofanyguaranteeorsecurity.cebshasstatedthat:astolossabsorptionona“goingconcern”basis-theinstrumentmust(a)helppreventinsolvencyand(b)nothinderrecapitalisationpreventinginsolvencyrequiresthat(i)noredemptionispermitted,(ii)theissuercancancelthecoupon,(iii)thehybridholdercannotpetitionfortheissuersinsolvencyand(iv)thehybridinstrumentwouldnotbetakenintoaccountindeterminingwhethertheissuerisinsolvent.ofthese,(iv)isarguablythemostdifficulttoachievewheretheinsolvencytestisbasedonthebalancesheet-ifinstrumentqualifiesas“debt”undertherelevantinsolvencylaw,amechanismforconversionintoanequityinstrumentorwrite-downofprincipal(whetherpermanentortemporary)maywork.thecapacityofaninstrumenttoabsorblossesina“liquidation”dependsonthedegreeofsubordination,lossabsorbency,inassessingwhetheraninstrumentrendersarecapitalisationmorelikely,abalancemustbestruckbetweenthehybridholdersandthepotentialnewshareholdersrespectiverights.mechanismsproposedbycebs(again)are(i)aconversionintoanequityinstrumentor(ii)apermanentortemporarywrite-downofprincipal,ineachcasetoameaningfulextent(i.e.,atleastparipassuwithshareholders),althoughitisunclearhowasharecanbe“writtendown.”oneoracombinationofthesemechanismscouldbeapprovedbyarelevantcompetentauthority.themechanism(s)shouldtakeeffect(a)immediatelyafterlossescauseasignificantdeteriorationinfinancialcondition/solvencyand(b)beforethesharecapitalisexhausted.inpracticethe“triggerpoint”wouldoccurwhenlosseshavesignificantlyreducedretainedearningsandotherreserves,butbeforetheissuerhasbreachedanyrequiredsolvencylevel.,lossabsorbency(cont.),hybridsthatdonotconvertintosharesarelimitedtoamaximumof35%ofthebankstier1capitalbeyondthe35%limitthehybridtier1capitalmustbeconvertibleintosharesandthetotalhybridtier1cannotexceed50%cebsconsidersthattheremustbeamandatoryconversionintoequityintheeventoftheissuersbreachofitsrequiredcapitalratioandperhapsalsoinother“emergencysituations.”inaddition,thecompetentauthorityshouldhavethepowertotriggertheconversionifnecessary,havingregardtoissuersfinancialcondition/solvency(i.e.,thesameconsiderationsasregardsconsentstocall/redemptionoracancellationofcoupons).,mandatoryconversion,baselframework,baselframework,inmiddecember,thebcbsannouncedfar-reachingproposalsforcomment,whichincludechangestothecomponentsofcapital;increasestothebasicminimumtier1andtotalrisk-basedcapitalrules;anda“capitalbuffer”conceptthatimposesaslidingscaleofenhancedregulatoryrestrictionstopaydividendsandbonusesifcapitalisnotabovetheminimum.,highlightsofbaselframework,emphasisonquality,consistencyandtransparencyofthecapitalbasethedefinitionoftier1capitalismovingclosertothedefinitionof“tangiblecommonequity”tier1(orgoingconcern)capitalmustconsistprincipallyofcommonequity,plusretainedearnings,netofregulatoryadjustments,includingdeductionsofintangibleassets,baselframeworktier1changes,theproposalenumeratesalistof14criteriatobesatisfiedinorderforcommonsharestobeincludedascommonequitycommonsharesmustbefullysubordinatedtoallotherclaimsinliquidationwithnofixedorcappedclaimonliquidation,exceptatthediscretionoftheissuingbankasaresultofthesecriteria,certaininstrumentswouldnolongerbeconsideredincludedforexample,step-upinstruments,cumulativepreferred,andtrustpreferred,regulatoryadjustments,theproposalswouldharmonizeregulatoryadjustments,includingadjustmentsfor:minorityinterests,deferredtaxassets,shortfallinreserves,goodwilland(b)theagencyhasdeterminedthatthreatstounitedstatesfinancialsystemstabilitymakesuchaconversionnecessary.(2)factorstoconsider.inestablishingregulationsunderthissubsection,theagencyshallconsider(a)anappropriatetransitionperiodforimplementationofaconversionunderthissubsection;(b)thefactorsdescribedinsubsection(b)(3)(a);(c)capitalrequirementsapplicabletothespecifiedfinancialcompanyanditssubsidiaries;and(d)anyotherfactorthattheagencydeemsappropriate.,wallstreetreformandconsumerprotectionactof2009(hr4173),housepassedhr4173ondecember11,2009;nosenateactionyetincludesasectionon“contingentcapital”authorizingthefederalreserveboardofgovernorstoissueregulations“thatrequireafinancialholdingcompanytomaintainaminimumamountoflong-termhybriddebtthatisconvertibleintoequitywhen(1)aspecifiedfinancialcompanyfailstomeetprudentialstandardsand(2)theagencyhasdet