S&P says contingent capital won’t do much to repair bank balance sheets
Standard & Poor’s is pouring cold water on “contingent capital,” the hot new way to shore up bank balance sheets recently popularized by Lloyd’s Banking Group (LLOY). In a new report on the topic, S&P made it clear it does not believe contingent convertibles will do much to help banks improve their tangible common equity.
As outlined in our criteria, we do not consider contingent capital securities to be a form of common equity. We can include them as hybrid equity depending on their exact features.
“We see contingent capital securities as introducing another potential tool to manage the capital base in times of stress. However, they are not being designed by banks to address the need to repair existing weak balance sheets,” S&Ps notes in Contingent Capital Is Not A Panacea For Banks.”They are one potential answer to one capital management question, but many banks will still need to address their capital positions through traditional forms of tangible equity.”
“One of the attractions of this contingent form of capital is that it adds a different strand to bank capital management strategy. The situations in which contingent capital securities convert into equity would also be transparent for investors from the start. There are certain practical difficulties, however.”
“The first is whether contingent capital securities will convert into capital early enough to help the bank. For contingent capital securities to prove effective as a buffer for senior bondholders, the conversion triggers need to be set at appropriate levels. However, this is difficult to determine before a crisis hits.”
“The second is that contingent capital securities may not be sufficiently attractive to investors at a price that is also attractive to the issuing banks. The level of investor demand for contingent capital securities is unclear, given the difficulty that investors may face in pricing the potential conversion risks. Therefore, it is too early to gauge how this market will develop.”
“While we expect to see material interest in (and debate around) this concept, we note that contingent capital securities are not designed to repair current weak capital positions and are not meant to act as a main plank of capital strategy. The ongoing debate about banks’ capital positions will need to cover other topics as contingent capital is not–and is not designed to be–the whole answer.”
You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
