Latam banks set to get the hybrid habit

Banks around the world have been issuing new Basle III-compliant tier 1 and 2 capital instruments, and a growing investor base has developed alongside this fast-growing asset class. Latin American banks, however, have largely remained interested observers. To date, the region has seen Basle III-compliant perpetual  tier 1 (AT1)transactions only from Banco do Brasil. The state-owned bank’s transactions also pre-dated Brazil’s adoption of Basle III and so had to include areas of structural flexibility to enable post-pricing governance changes to comply with what has now been adopted.

Meanwhile, Santander’s banks in Mexico and Brazil are still the only issuers of Basle III-compliant T2 instruments, with the latter being offered only to existing shareholders. The Mexican unit of Santander sold just $300 million of its total $1.2 billion T2 trade in December 2013 to private investors (Santander’s Spanish bank bought the balance).

Despite the lack of issuance, bankers and rating agencies report strong interest from Mexican and Brazilian (the only two Latin American jurisdictions to have adopted Basle III) banks to issue such hybrid deals. Supply is there, they report, but country-specific regulatory idiosyncrasies, coupled with slowing economies and credit growth, have blunted requirements for fresh capital. Also, banks from the region are already highly capitalized and enjoyed a good banking crisis thanks to lessons learned from recent regional-specific crises; so the rebuilding imperative that is leading European and other banks to issue hybrid capital transactions isn’t driving Latin American banks to market.

Yet they will come, although slowly and more through the lens of optimizing capital structure, according to Stanley Louie, head of new products at Citi: “We have been speaking to the banks in Latin America and there is clearly interest in issuing these securities, and we expect to see some transactions this year.”

Alejandro García, a senior banking analyst at Fitch Ratings in Mexico, says: “There are high stocks of legacy tier 1 and tier 2 hybrids in Mexico and Brazil that over time will need to be replaced and there are good prospects for deals in the coming years.” However, because of the grandfathering of existing tier 1 and tier 2 transactions there is no urgency and García foresees “isolated examples” of deals in the next couple of years before the market heats up as legacy issues lose their capital recognition under Basle III, becoming expensive debt rather than cheap capital.

Raphael Robelin, co-CIO at BlueBay Investments, is bullish on issuance generally, while acknowledging that banks from emerging markets, which have been on average slower to adopt Basle III regulations, will lag behind those recapitalizing in the developed markets. “Banks will have a chance of owning 1.5% of their RWA [risk weighted assets] in tier 1 Basle III securities and 2% in tier 2 – or they can issue equity instead,” he reasons. “Because most of these hybrids are going to be tax deductible in most jurisdictions, if you imagine a cost of equity of 10% and an average tax rate of 20% – as long as the banks can issue these instruments at a coupon lower than 12.5%, it is cheaper to do so than issue equity. Between today and January 1 2019 when Basle III goes live there should be hundreds of billions of dollars of issuance.”

For the full article visit Euromoney Magazine

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