* RBNZ sees little value and added complexity in hybrid notes
* Cites precedents in Italy and Spain as reasons for caution
* Bank consultation open until Sept. 8
By John Weavers
SYDNEY, Aug 21 (IFR) - New Zealand’s central bank has issued a stinging critique of Additional Tier 1 capital, casting doubt over the value of a product designed to safeguard the global financial system.
The Reserve Bank of New Zealand (RBNZ) has tabled proposals to restrict Tier 1 capital instruments to common equity and preference shares, in a move that threatens to rule out future issuance of callable AT1 securities.
The RBNZ outlined its misgivings about the AT1 format in its July Capital Review Paper 2 consultation document, which is open to responses until Sept. 8.
Although the RBNZ lists various factors peculiar to the New Zealand market in support of its proposals, the document raises broader questions about the value of contingent debt instruments like AT1 and Tier 2 bonds.
“The loss-absorbing quality of ordinary shares is far greater than that provided by contingent debt, thus the quality of capital in the regime has arguably been harmed by accepting contingent debt as Tier 1 capital,” the paper says.
“As a general direction, the Reserve Bank prefers to move towards a regime that accepts subordinated debt without triggers as capital, but not contingent debt, and, moreover, accepts such debt as lower tier regulatory capital, not Tier 1.”
Although banks can still offer contingent debt, that is, debt with pre-defined triggers for conversion or writeoffs, the proceeds will not count towards regulated capital levels.
The RBNZ says its aim is “a capital regime that is easy for banks to comply with and simple to administer”. It says it has encountered “difficulties” in its oversight of contingent debt, for instance having to disqualify outstanding bank bonds as bank capital even though it had not objected to them initially.
Those bonds, issued by Kiwibank Ltd, ironically secured a favourable ruling from the RBNZ days after the publication of the consultation paper, requalifying them as regulatory capital.
More generally, the RBNZ expresses a lack of confidence in “going-concern” conversion debt instruments introduced since the global financial crisis, which, it believes, add complexity and provide little regulatory value, while being open to legal challenges. LESSONS FROM EUROPE The review paper cites two recent experiences in Europe to cast doubt on the performance of contingent debt instruments.
In the case of Italy’s Monte dei Paschi di Siena SpA , it notes that 4.5 billion euros ($5.3 billion) of contingent debt was converted to ordinary shares after the bank was deemed insolvent earlier this year. However, retail investors holding 1.5 billion euros of the debt were compensated because the authorities decided the notes had been miss-sold. In that sense, that portion of the debt did not absorb losses, but was instead treated as senior debt, the paper argues.
In Spain, holders of Banco Popular’s AT1 contingent notes did not enact going-concern triggers that could have recapitalised the bank before its failure in June 2017. As a result, they incurred losses equal to the face value of their debt holdings, an outcome that suggests the only meaningful trigger was the non-viability trigger, the paper says.
The RBNZ lists a number of homegrown characteristics that it says raise questions about contingent capital. For instance, almost 90 percent of the AT1 capital issued in New Zealand by the big four banks has gone to their parent entities in Australia. The apparent substitution of AT1 debt for ordinary share capital is of concern to the central bank, as ordinary capital absorbs losses on an ongoing basis, whereas contingent debt seems likely to play that role only once the bank has become non-viable.
Public AT1 offerings are rare among New Zealand’s four majors with only one outstanding – ANZ Bank New Zealand’s NZ$500 million 7.20 percent perpetual non-call five retail ANZ Capital Notes, issued in March 2015.
Additionally the New Zealand majors have A$2.8 billion of oustanding AT1 debt placed with their Australian parents.
New Zealand’s big four, which account for around 90 percent of aggregate bank assets in the country, are locally incorporated subsidiaries of their Australian-incorporated banking parents.
They are subject to Australian and New Zealand bank capital regulations and capital issued by ANZ Bank New Zealand, ASB Bank Ltd, BNZ and Westpac New Zealand Ltd qualifies as capital both for the New Zealand bank and Australian parent. CLARITY NEEDED
If callable subordinated notes no longer count as capital, non-majors like Kiwibank could be disadvantaged by being limited to common equity and retained earnings for their capital adequacy requirements.
“The majors would still be able to raise capital at a group level and then pipe through whatever they need to in support of their New Zealand subsidiaries as AT1 or subordinated debt,” said one Wellington-based banker.
“These internal capital deals don’t need to consider whether they are marketable unlike the non-majors which need the support of retail investors”.
He is worried that only allowing truly perpetual notes with no call date would be a hard sell to retail investors and hopes the RBNZ eases the proposed criteria to allow redemptions.
The Reserve Bank has been less clear on Tier 2 issuance, but its proposal for long-term subordinated notes with no loss-absorbency suggest a preference for 10-year bullet rather than traditional 10 non-call five structures that could also alienate much of the current investor base, according to the banker.
Banks have until Sept. 8 to submit their responses, with the RBNZ expected to release a final report early next year. (Reporting by John Weavers; Editing by Vincent Baby and Steve Garton)