As part of the covid-19 policy solution, banks are benefiting from an easing of regulatory requirements. While this is generally supportive for banks' fundamentals, risks for some investors could increase, according to research published today by Scope Ratings.
Regulators have responded quickly to ensure that banks are able to support the economy, taking measures to increase the amount of capital available to banks, easing requirements and exercising flexibility to soften the impact of expected credit losses.
"While these measures are generally supportive of bank fundamentals, the implications for AT1 (additional tier 1) investors are more nuanced," said Pauline Lambert, executive director in the financial institutions team of Scope Ratings and author of the latest AT1 quarterly, published today.
The easing of capital requirements is helpful to an extent. While drawing down on capital buffers is permitted and even encouraged, breaching the combined capital buffer still has consequences.”
"The easing of capital requirements is helpful to an extent. While drawing down on capital buffers is permitted and even encouraged, breaching the combined capital buffer still has consequences."
For AT1 investors, the most relevant relaxations in capital requirements have been the removal or reduction of countercyclical and systemic risk buffers in countries where these had been actively used before covid-19: the countercyclical buffer in the UK and Norway and the systemic risk buffer in the Netherlands and Finland.
Meanwhile, strong regulatory guidance to restrict dividends and bonuses, with European AT1 issuers complying in some manner, has strengthened banks' solvency positions. But this has raised concerns about AT1 securities.
"This supervisory decisiveness raises questions about the likelihood of regulatory intervention in the payment of AT1 coupons," Lambert cautioned. For now, major European AT1 issuers generally remain sound, so Scope sees limited risks. However, as the impacts of covid-19 persist and issuer fundamentals deteriorate due to losses and capital depletion, the risk of non-payment will increase.
"Preventing payment of AT1 coupons is a severe step that would normally happen after other supervisory interventions. In the current environment where dividends and bonuses have already been cancelled and the market is not conducive to asset sales, stopping AT1 distributions becomes a more likely scenario," Lambert continued.
"Supervisors could issue blanket guidance not to pay AT1 coupons to limit the risk of highlighting any individual bank's relative weakness."
Not all banks will suffer from the economic fallout to the same degree due to differences in the robustness of business models and risk management capabilities. Issuers that already were under pressure before covid-19 remain at a disadvantage.
"It is still early days and the capital positions of banks have not weakened to a level that threatens combined capital buffers. Regulators and supervisors appear to be highly supportive of banks, and further measures are possible. Again, this should be positive for banks overall but not necessarily for AT1 investors," Lambert said.
The full Scope report can be downloaded here.