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* US regulators mull 6% leverage ratio
* European banks struggle to meet minimum 3% requirement
* Volatile market could stall capital issuance
By Aimee Donnellan and Danielle Robinson
LONDON, July 5 (IFR) - European and US banks are facing theprospect of having to issue much more subordinated debt, and ata much higher cost, as regulators stamp out low leverage ratiosand investors demand higher concessions for market volatility.
In the US, the Federal Reserve is thought to be consideringdoubling the leverage ratio for its largest banks to 6%, whileacross the pond, European banks are struggling to meet theminimum 3% requirement.
"There are certainly a number of US and European banks thatwould have to issue hard capital in the form of equity orAdditional Tier 1 to meet the new leverage requirements," saidAlexandra MacMahon, head of EMEA FIG debt capital markets atCitigroup.
"At the moment, there is still a lack of clarity on the taxtreatment of Additional Tier 1, which is stalling certain banksfrom raising this form of capital. Added to that, as volatilityreturns, investors are flexing their muscles on pricing, whichcould make issuing subordinated debt more costly."
As it currently stands, US banks Citigroup, JP Morgan, Bankof America Merrill Lynch, Goldman Sachs and Morgan Stanley areall comfortably above the minimum 3% ratio. But in Europe, BNPParibas is the only eurozone bank to surpass that minimumrequirement.
RBS and UK headquartered HSBC have both exceeded the ratiotarget, according to Barclays research.
Despite the discrepancy between US and European banks'capital needs - which some say could damage the latter'scompetitiveness - bankers seem relatively calm about issuanceprospects.
They argue that banks are in general well capitalised andcan therefore afford to sit and wait for calmer marketconditions.
"If markets do stabilise, we could see some deals inSeptember, but I don't think anyone is expecting a big gush,"said Daniel Bell, head of EMEA DCM capital products at Bank ofAmerica Merrill Lynch.
"No one is in a particular rush to do deals. It's more abouthow they can optimise their balance sheets and about taking outold structures and putting in new ones, so certainty oftreatment - regulatory and tax - is more important at thisstage."
European banks, however, were given a further push to issuecapital on Thursday, when the European Banking Authority (EBA)announced that Tier 1 deals that have passed their call datesand stepped up would not be grandfathered as Tier 2 capital.
This means that if banks want to maintain their currentcapital levels, they will have to issue Additional Tier 1 andTier 2 debt, adding further pressure at a time when marketsremain fragile.
US TREATMENT
In the US, there is even more of an impetus for financialinstitutions to get going. This week, the Fed ruled that thebanks with over USD250bn in assets cannot, as many had hoped,keep any of their old Tier 1-eligible Trust Preferred Securities(TruPS) as Tier 2 subordinated debt, although smaller banks can.
The decision, especially in a rising-rate environment wherethe biggest banks are battling to safeguard themselves fromlosses on the billions of dollars of Treasury securities ontheir books, could spur a new round of extra capital issuance tobuffer Tier 1 levels against volatile swings once the new rulesare effective.
For banks with less than USD250bn of assets, however, "theFed's final interpretation of Basel III is better thanexpected", said Kevin Ryan, co-head of FIG DCM at MorganStanley.
The smaller banks can continue holding some TruPS as Tier 2.They are also not subject to the higher supplemental leverageratio rules, and can continue to elect that most elements of'All Other Comprehensive Income' (AOCI) do not have to beincluded in regulatory capital calculations.
The biggest US banks, however, have lost their lobbyingefforts to keep the gains and losses on tradeable securitiescordoned off from regulatory capital.
In the US, they are seeking to keep putting Treasuries andother actively traded securities in the 'Available For Sale'bucket, which is counted as AOCI.
"The potential losses (on actively traded securities) in arising rate environment is a concern, because it could be adirect hit to capital," said one DCM head.
"So one thing the G-SIFIs are focused on is the capitalimplications of that - does it mean the big banks should issuemore preferred or subordinated debt to bolster their capitalpositions? That's something they need to think about."
In Europe, they are calling for further clarity on the taxtreatment of AT1 so they can fatten up their capital cushionsand meet the leverage ratio while yields are still relativelylow.
FED'S UNFORTUNATE TIMING
The renewed focus on leverage ratios, and therefore capital,comes at an unfortunate time for European banks. Increasinglyrisk-averse investors are looking for higher yields tocompensate them for perceived higher interest rate risk, whichmeans issuing capital will be a challenge.
Since the Fed warned it could reduce its bond buyingprogramme, the cost of insuring subordinated debt has balloonedby over 100bp to a peak of 293bp at the end of June, accordingto Tradeweb.
The fact that European banks have raised in excess ofEUR700bn in capital from the start of the financial crisis todate means they have a bit of breathing room to adjust to theever-changing regulatory environment.
"The market has to give banks and regulators time to adjust,and banks are not going to be under imminent pressure to raisecapital," said Khalid Krim, head of capital solutions, EMEA, atMorgan Stanley.
"We need to be able to benchmark and compare banks, and soassessing the quality of assets is crucial. Once that is done,the EBA and ECB stress tests in 2014 will be much morecredible."
